70562 Georgia Agricultural and Rural Enterprise Development Agricultural and Rural Enterprise Development Agriculture and Rural Development Sustainable Development Department Europe and Central Asia Region December 2009 CONTENTS Abbreviations and Acronyms....................................................................................................................................... Acknowledgements ..................................................................................................................................................... Executive Summary .................................................................................................................................................... i I. Introduction ..................................................................................................................................................... 1 II. Structure of the Rural Economy ........................................................................................................................ 2 A. The Rural Economy ..............................................................................................................................................2 B. Structure of the Farm Sector ...............................................................................................................................6 C. The Structure of the Non-Farm Sector ...............................................................................................................10 III. Policy Framework and Constraints ................................................................................................................. 16 A. Macroeconomic Management ..........................................................................................................................16 B. Recent Global and Regional Influences .............................................................................................................16 C. Financial Services ...............................................................................................................................................17 1. Banks.............................................................................................................................................................17 2. Leasing ..........................................................................................................................................................22 3. Microfinance Institutions..............................................................................................................................23 4. Credit Unions ................................................................................................................................................24 D. Agricultural Trade Policy....................................................................................................................................25 E. Land Reform ......................................................................................................................................................27 F. Public Expenditure on Agriculture ....................................................................................................................32 G. Agricultural Services ..........................................................................................................................................39 1. Machinery .....................................................................................................................................................39 2. Irrigation and Drainage .................................................................................................................................41 3. Seeds .............................................................................................................................................................44 4. Sanitary and Phytosanitary Control ..............................................................................................................46 5. Marketing .....................................................................................................................................................52 H. Rural Infrastructure ...........................................................................................................................................55 I. Prioritization of Policy Challenges and Constraints ...........................................................................................57 IV. Policy Outcomes ............................................................................................................................................. 59 A. Rural Employment, Incomes and Poverty ..........................................................................................................59 B. Farm Sector .......................................................................................................................................................61 C. Non-Farm Sector................................................................................................................................................67 V. RECOMMENDATIONS ..................................................................................................................................... 71 A. Prioritization of Farm and Non-farm Sectors.....................................................................................................71 B. Recommendations for Reform ...........................................................................................................................72 Annex 1 Map of Georgia List of Tables Table 1 Prioritization of Recommended Reforms and their Implications for Public Spending ...................... xiii Table 2 National Employment and Wages by Sector ....................................................................................... 3 Table 3 Poverty in Tbilisi and the Regions ........................................................................................................ 5 Table 4 Land Altitude........................................................................................................................................ 6 Table 5 Number of Registered Enterprises by Region.................................................................................... 11 Table 6 Registered Enterprises by Type of Ownership, 2007......................................................................... 11 Table 7 Number of Registered Enterprises (small, medium and large) by Business Activity, 2007 ............... 12 Table 8 No. of Small, Medium and Large Enterprises in the 2007 Enterprise Survey .................................... 12 Table 9 Estimated Numbers of Small, Medium and Large Enterprises by Region as of Dec. 2007................ 13 Table 10 Estimated Regional Distribution of Small, Medium and Large Enterprises as of Dec. 2007 ........... 13 Table 11 Contribution of Small Medium and Large Enterprises to Total Enterprise Turnover 2007............. 14 Table 12 Regional Contribution of Tbilisi and Regional Enterprises to Total Enterprise Turnover 2007 ....... 14 Table 13 Georgia’s Commercial Banking System (End of period) .................................................................. 18 Table 14 Assets and Liabilities of Non-Bank Depository Institutions (Credit Unions) (GEL 000) ................... 25 Table 15 Comparison of Tariffs on Agricultural Products with Selected Trading Partners ........................ 26 Table 16 Comparison of Tariffs in Georgia and the EU by Product ................................................................ 26 Table 17 Exports to Major Trading Partners and Duties Faced ...................................................................... 26 Table 18 Structure of Land Ownership at the End of 2002 (Thousand ha) .................................................... 27 Table 19 Land Taxes ....................................................................................................................................... 30 Table 20 Budget by Organization (GEL 000) ................................................................................................... 33 Table 21 AA Membership Fees ....................................................................................................................... 43 Table 22 LTD Cost Recovery (January to November 30th 2008) GEL .............................................................. 43 Table 23 Georgia: Change in Monetary Income of Rural Households ........................................................... 60 Table 24 Changes in Regional Sources of Monetary Rural Incomes 2003-2007 ............................................ 61 Table 25 Growth in Number of Registered Enterprises by Region................................................................. 68 Table 26 Registered Enterprises by Ownership, 2003-07 .............................................................................. 68 Table 27 Number of Registered Enterprises (small, medium and large) by Business Activity, 2003-07 ....... 69 Table 28 Prioritization of Recommended Reforms and their Implications for Public Spending .................... 72 List of Figures Figure 1 Agricultural and Environmental Budgets by Functional Category 2007-2009 ...................................vi Figure 2 Regional Distribution of the Population ............................................................................................. 2 Figure 3 Rural Incomes 2007 ............................................................................................................................ 4 Figure 4 Composition of Rural Income in 2007 ................................................................................................ 4 Figure 5 Land Area (ha) .................................................................................................................................... 6 Figure 6 Number of Holdings by Farm Size (2004) ........................................................................................... 7 Figure 7 Distribution of Livestock by Region .................................................................................................... 8 Figure 8 Cropping by Region............................................................................................................................. 9 Figure 9 Commercial Bank Outstanding Loan Portfolio to Resident Legal Entities and Individuals ............. 19 Figure 10 Overdue Loans and Accrued Interest as a Percentage of the Outstanding Loan Portfolio............ 19 Figure 11 Composition of the Loan Portfolio of the Commercial Banks ........................................................ 21 Figure 12 Commercial Bank Loan Portfolio for Legal Entities in Agriculture, Forestry and Fisheries ............ 21 Figure 13 Responsibility for Land Management and Administration............................................................. 32 Figure 14 Agricultural Budgets as a Percentage of GDP ................................................................................. 33 Figure 15 Agricultural and Environmental Budgets by Organization 2007-2009 ........................................... 36 Figure 16 Agricultural and Environmental Budgets by Functional Category 2007-2009 ............................... 37 Figure 17 Agricultural and Environmental Budgets for Public and Private Functions ................................... 38 Figure 18 Comparison of the Regional Distribution of the Population in 2003 and 2009 ............................. 59 Figure 19 Comparison of Sources of Rural Incomes in 2003 and 2007 .......................................................... 61 Figure 20 Comparison of Agricultural GDP and GDP ...................................................................................... 62 Figure 21 GDP Agriculture, Forestry and Fishing............................................................................................ 62 Figure 22 Real Value Added (VA) per Employee, by Sector .......................................................................... 63 Figure 23 Sown Areas ..................................................................................................................................... 64 Figure 24 Livestock Numbers ......................................................................................................................... 64 Figure 25 Crop Yield Trends............................................................................................................................ 65 Figure 26 Food and Beverage Exports ............................................................................................................ 66 Figure 27 Share of Food and Beverage Exports.............................................................................................. 66 Figure 28 Food and Beverage Imports ........................................................................................................... 66 Figure 29 Food and Beverage Trade ............................................................................................................... 67 ABBREVIATIONS AND ACRONYMS AA Ameliorative Associations ASC Agricultural Service Cooperatives CIS Commonwealth of Independent States CU Credit Union DCFTA Deep and Comprehensive Free Trade Agreement DPU Distinctness, Purity and Uniformity ECA Europe and Central Asia EMPPO European and Mediterranean Plant Protection Organisation EPPO European Plant Protection Organisation FAO Food and Agriculture Organization FTA Free Trade Agreement GEL Georgian Lari GEPLAC Georgian European Legal Advice Centre GSP Global System of Preferences Ha Hectares HACCP Hazard Analysis and Critical Control Point HBS Household Budget Survey IDCDP Irrigation and Drainage Community Development Project IPPC International Plant Protection Convention ISTA International Seed Trading Association LSMS Living Standard Measurement Survey MENP Ministry of Environmental Protection and Natural Resources MDF Municipal Development Fund MFN Most Favoured Nation MOA Ministry of Agriculture MOE Ministry of Economic Development MOF Ministry of Finance MT Metric tonne NARP National Agency for Registration of Property NS National Service for Food Safety, Veterinary Services and Plant Protection OIE International Organization for Animal Health PCA Partnership Cooperation Agreement PFI Private Financial Institution PPP Public Private Partnership RASFF Rapid Alert System for Food and Feed SDLM State Department for Land Management SIDA Swedish International Development Agency SME Small and Medium Enterprise SPS Sanitary and Phytosanitary UNDP United Nations Development Program UPOV Union for Protection of Varieties USAID United States Agency for International Aid USDA United States Department of Agriculture VAT Value Added Tax VCU Value for Cultivational Use VET Vocational Education and Training VMP Veterinary Medicinal Products WTO World Trade Organization ACKNOWLEDGEMENTS The Bank team was led by Peter Goodman (Senior Agricultural Specialist, ECSS1). Team members were Ramesh Despande (Bank Consultant, SME Development and Finance), Vladimir Evtimov (FAO Consultant, Land Reform), David White (FAO Consultant, Seeds Industry), and Dick G. Groothius (FAO Consultant, Sanitary and Phytosanitary Control). The peer reviewers for the study were Iain Shuker (Sector Leader, EASER), and Malcolm Childress (Senior Land Administration Specialist, LCSAR), Sari Soderstrom (Lead Operations Officer, ECSS1). The team is grateful for the consultations and data provided by the government ministries and agencies (State Chancellery, Ministry of Economic Development, Ministry of Finance, Ministry of Agriculture, Ministry of Environmental Protection and Natural Resources, Ministry of Regional Development, Municipal Development Fund); the numerous donors projects funded by European Commission, USAID, USDA, SIDA, UNDP, FAO, CARE International, and CHF International; and representatives of the private sector, including farmers, commercial banks, microfinance organizations, ameliorative associations, machinery suppliers and agricultural input suppliers and agro-processors. EXECUTIVE SUMMARY 1. Structure of the Rural Economy The rural population is highly dependent on subsistence agriculture and public transfers. 1. Georgia is only moderately urbanized and about 65 percent of the population is employed in rural areas. Of these, most work in the agricultural sector, which employs 53 percent of the total workforce, including self-self subsistence farming and paid labor, which is employed at wages of less than 50 percent of average national wages. The other 12 percent of the workforce, which work in rural areas, are employed in the rural non-farm sector. 2. Subsistence agriculture, which accounts for 73 percent of the total rural employment, is the main source of income for the majority of rural households, although there are significant differences between income groups. The lowest income groups are more dependent on public transfers, while higher income groups are more dependent on agriculture. Poverty in rural areas (29.7 percent) is considerably higher than in urban areas (18.3 percent), although there are considerable differences between the regions, were poverty rates range from 59.4 percent in Shida Kartli to 7.6 percent in Kvemo Kartli. The rural economy’s contribution to total output is low but it supports the majority of the population. 3. The contribution of the rural economy to total output is low and estimated to be less than 16.5%, 10% of which is generated by the farm sector, which employs 53% of the workforce and less than 6.5% by the non-farm sector, which employs only 12% of the workforce. Labor productivity in the agricultural sector is particularly low and this is consistent with low levels of investment in the sector. 4. Despite the agricultural sector’s low contribution to overall economic activity, it provides the main source of income and food security for over half the population. Consequently, while changes in the productivity of the agricultural sector may only have a modest effect on overall economic growth, they will have a major impact on rural household incomes, poverty levels and equity of income distribution in the short term, as well as generating greater demand for goods and services produced by urban and rural based businesses in the longer term. The farm sector is dominated by small fragmented farms. Land privatization is well advanced. 5. The farm sector is dominated by small private farms with an average farm size of 1.2 ha, 93% of with less than 2 ha of land, with an average of 2.3 plots per farm. About half of output is generated from crops and half from livestock. The government has considerably expanded private ownership of land. At the end of 2008, 32% of all agricultural land or 78% of agricultural land, excluding pastures, was under private ownership and the government plans further land privatization. The non-farm sector is small and dominated by small and medium trading enterprises. 6. The data does not distinguish between rural and urban enterprises but registered SMEs in the regions are used as a proxy for the rural non-farm sector. The non-farm sector in the regions is dominated in terms of numbers, by private, individually owned enterprises. The majority of non-farm enterprises in the regions are small (89%) or medium (11%) and the majority (77%) are engaged in trade. Other significant non-farm business activities include i manufacturing (6%), transport & communications (3%); real estate (3%); hotels and restaurants (2%); and construction (2%). 2. Policy Framework and Constraints 7. This section describes government policies and key constraints affecting the wider rural economy including, reforms in macro-economic management, recent global and regional influences, and the financial sector. It then reviews agricultural trade policy, land reform, public expenditure in agriculture and agricultural services, including, agricultural machinery services, irrigation and drainage, seeds, sanitary and phytosanitary control and veterinary services and finally marketing and advisory services. Macroeconomic Management and Recent external influences The government has established relatively strong macro-economic environment and a good climate for doing business. This has been reflected in non-farm sector growth but the farm sector has not been able to respond. 8. The government has established a relatively strong macro-economic environment. In general, annual inflation has been contained to single figures, revenue collection has been improved and the budget deficit kept under control. The Central Bank has implemented a managed floating exchange rate although there has been considerable exchange rate appreciation due to high FDI inflows. Growth has been impressive, peaking at 12.4 percent in 2007, before declining to 3.5 percent in 2008. This success has been mirrored in the rural non-farm sector but not in the agricultural sector which has grown at an average of -1.3 percent per annum between 2003 and 2008, suggesting that weakness in the agricultural reform program need to be addressed. 9. Against this background of responsible macroeconomic management, a number of external factors including, the 2006 Russian trade embargo, the financial crisis and global economic recession, the food crisis, and the August 2008 war with Russia, have had a substantial negative impact on the whole economy, depressing demand, reducing investor confidence, constraining lending, and creating pressure on public spending and household budgets. 10. The study now looks at some of the specific policies and constraints affecting the rural economy. Financial Services Commercial Banks The financial sector had shown very impressive growth up until the global financial crisis. The crisis has severely affected SME lending but even before the crisis, rural SME and agricultural lending represented a small percentage of commercial bank loan portfolios and borrowing costs were prohibitive for most rural businesses. 11. The financial sector had shown impressive growth up until the global financial crisis. Two banks (Bank of Georgia and TBC Bank) dominate the sector, along with about six medium- sized banks (Bank Republic, ProCredit Bank, Cartu Bank, VTB, Peoples’ Bank, Tao Private Bank). According to the recent IMF report (January 2009), the financial soundness indicators of commercial banks have shown significant worsening since late 2007, with decreasing capital adequacy and liquidity ratios and increases in non-performing assets. The previously impressive growth in commercial banks assets ceased in 2008 and started to contract in 2009. ii 12. SMEs lending is estimated to be in the range of 20% to 30% of total commercial bank lending. The Georgian banks are predominantly urban based and are engaged in short-term lending. The provision of credit to SMEs in non-trading sectors in rural areas is very limited. Most commercial banks in Georgia, except perhaps ProCredit Bank and Kor Standard Bank, do not seem to have systematically laid out their corporate strategies for SME lending, especially to rural SMEs which they consider as highly risky. Although lending to agriculture increased significantly between 2005 and 2009 along with growth in total lending, it still represents only 1-2 percent of the commercial bank’s outstanding loan portfolio to legal entities. 13. Since mid 2008, the majority of commercial banks have temporarily suspended or reduced lending to SMEs and have begun to review, reduce and recall existing loans. These measures have been in response to SMEs’ growing default rate (20-25 percent). Any major restructuring of SME loan portfolios, however, has implications for commercial banks, which are already suffering liquidity problems from the financial crisis. 14. Interest rates on bank loans vary from 20% to 30% p.a. As the bulk of the commercial bank loans to SMEs (over 60%) are indexed to the U.S. dollar, they carry an exchange rate- induced risk of 12-15% of the loan amount, making bank credit expensive and only viable for highly profitable enterprises, especially those engaged in trading of imported consumer goods. Commercial banks’ collateral requirements are very conservative. While residential or commercial buildings are readily accepted as collateral, land is taken as collateral only in urban areas, which constrains many rural businesses access to credit. Leasing The leasing industry is still in the early stages of development and not currently an important source of rural finance. Legislative reform in relation to taxation of leasing companies needs to be addressed. 15. Georgia’s leasing industry is quite undeveloped. There are two main leasing companies in Georgia, TBC Leasing (subsidiary of TBC Bank) and GLC (subsidiary of Bank of Georgia). There are two other relatively new leasing companies, AG Leasing and Parex Leasing, which have relatively small market shares. Leasing activity remains concentrated in Tbilisi as the leasing companies are reluctant to operate in the regions. In terms of taxation, leasing companies are treated as product delivery companies not financial service providers. Under current legislation, VAT is spread over the life of the lease and collected with each installment of the lease payment but the leasing company is required to charge VAT (18%) on the interest portion of the installment as well. Microfinance Institutions There are five well established MFIs and about twenty-five nascent MFIs. 16. Most of the 30 MFIs are in early phases of development except FINCA, CREDO, Crystal, Lazaka Capital and Constanta. MFIs have overdue loans up to 5-6% of the total portfolio, compared to the earlier low level of about 1% until August 2008 conflict. Georgia’s law prohibits microfinance organizations from accepting deposits. Any transition to licensing of deposit taking MFIs in future would require a more rigorous regulatory framework and adequate resources for regulation to safeguard the interests of depositors. iii Trade Policy Georgia has pursued a liberal trade policy which will encourage greater competitiveness .The agricultural sector is lightly protected by low import tariffs but on average these are much lower than many of Georgia’s trading partners. 17. Georgia has aggressively liberalized its trade policy through abolition of import/ export quotas, conversion of non-tariff barriers to tariffs, reduction of tariff rates, simplification of tariff rates from sixteen to three rates (0 percent, 5 percent and 12 percent) and the on- going pursuit of free trade agreements (FTAs). The trade agreements to which Georgia is party include: i) WTO under which Georgia enjoys Most Favored Nation (MFN) treatment with 150 member countries and is a beneficiary of Generalized System of Preferences of the EU, US, Canada, Switzerland, Japan, and Turkey; ii) FTA with Turkey (2008); iii) FTA with CIS Countries; iv) Generalized System of Preferences (GSP) with EU (1999 renewed 2005); v) GSP US, Canada, Switzerland and Japan. Georgia is currently in discussions with the EU on initiation of negotiations for an EU FTA and is considering pursuit of a US FTA. 18. Georgia has established a lightly protected agricultural trade regime in which agricultural products enjoy a higher level of protection than other products. However, Georgian farmers face tough competition from its main trading partners, whose agricultural sectors enjoy higher levels of trade and protection than Georgia, both in terms of MFN applied tariffs, the percentage of items which are duty free and non-trade protection through various subsidies (notably the EU and Kazakhstan). Georgia has a lower average MFN applied tariff than the EU on all top ten product groups. Turkey has a simple average applied MFN tariff of 46.7% compared to Georgia’s 8.8% in Georgia. While Georgia benefits from preferential tariffs under its FTA with Turkey, this does not include a number of key agricultural products groups and the tariff quota volumes on many key products to which preferential tariffs do apply, are very low. Considerable appreciation of the exchange rate has clearly added to the difficulties of Georgian agriculture in competing with their trading partners. Land Reform The government has substantially increased the private ownership of land and established a highly efficient registration system but there are errors in many early land rights documents, which need to be resolved in preparation for a more active secondary land market in future. The recent forestry leasing arrangements do not ensure good long term forest management. 19. The current government substantially expanded the privatisation of land during the second phase of land reform and further privatisation of the majority of the remaining state owned agricultural land (expect pastures) is planned. A highly efficient NAPR has been established. These are considerable achievements but the rural land market in Georgia is still weak due. The key cause of the weak market for land is mainly low competitiveness of the sector but there are a number of factors, notably incomplete land registration, which may constrain the market in future as it becomes more buoyant. 20. Land Registration: The percentage of registered immovable rural properties (first registration) is only around 30%. First registration of the property is a pre-requisite for registering secondary market transactions (sale, lease, mortgage), because it provides the ultimate clear title necessary for secondary market transactions. The rights identification documents issued in some areas during the first phase of land privatization, contain numerous technical errors, since they were based on inaccurate cadastral maps. In case of iv first registration, approximately 20% of these title documents reach end up in the administrative courts for rectification. 21. Institutional arrangements for land policy: After the dissolution of State Department for Land Management (SDLM) in 2004, management functions for lands in public ownership are fragmented between several ministries and local self-government bodies. The allocation of lands in public ownership between the central government / line ministries, and the local governments (municipalities, sakrebulo) is still incomplete, and there is no comprehensive inventory or cadastral record of lands in public ownership, leading to poor land governance. In general, the institutional arrangements and capacity of sakrebulo to deal with all land management issues appears to be inadequate. 22. Forestry leases: In 2009, the government put in place new plans to increase private sector management of some forest land through short-term leases. These leases are potentially problematic because the delimitation of forests is poor and because they are drafted without a prior inventory of the forest resources to be leased out by government. Instead, the lessee is required to conduct an inventory and to draft a management plan but it is difficult to see how the authorities will be able to assess the accuracy of the basic data used and accordingly the technical and environmental feasibility of these plans. Public Expenditure on Agriculture and the Environment There has been a positive shift in spending away from short term input provision towards longer term investments in irrigation and drainage infrastructure. However, in contrast to the considerable spending on machinery, which is essentially a private sector function, there is a void in spending on essential public services. 23. There have been substantial changes in the nature of public spending on agriculture and the environment between 2007 and 2009. The shift in MOA spending (Figure 1) from direct consumer support (in the form of food aid) in 2007, to direct producer support (in the form of input provision) in 2008, to greater capital investment (in the form of irrigation and drainage rehabilitation and provision of machinery) in 2009 is a positive move towards longer term investment in the sector. However, in 2009 over 20% of the agricultural and environmental budget, including over 50% of the MOA budget, is for what are essentially private sector type investments (specifically the machinery program) [It is understood that funding for the machinery program may cease in 2009, although it remains a prominent feature in the MOA agricultural strategy 2009-2011]. In contrast to the considerable spending on these private sector type investments, there is a void in spending on essential public services to protect public health, (such as disease control programs), to protect the environment (such as laboratory testing) and to stimulate the private sector (such as advisory services). The required investment in these essential public services would represent a relatively small percentage of total current spending. v Figure 1 Agricultural and Environmental Budgets by Functional Category 2007-2009 Source: Ministry of Finance Agricultural Services a) Machinery The government machinery program has helped to establish some major machinery suppliers in Georgia and provided much needed machinery but the program does not provide a good foundation for the long term development of machinery services - government has addressed what is essentially a failure in the financial market with intervention in the machinery market. 24. The Bank undertook a study of agricultural mechanization in the ECA region. The trend in mechanization in Georgia between 1995 and 2005 was similar to that in other transition countries. While interest rates have declined and real farm wages have increased, tractor use remained stable, and combine use declined. Stagnant mechanization during this period is also reflected in capital to labor ratios. During this period, while tractor use remained stable, imports were low and old machinery was not replaced, leading to a decline in the overall condition of machinery. 25. The current government responded to stagnant mechanization by investing heavily in government funded machinery programs. Total expenditure on machinery programs is budgeted for GEL 22.4 million in 2009. [It is understood that funding for the machinery program may cease in 2009, although it remains a prominent feature in the MOA agricultural strategy 2009-2011]. Machinery has been procured by government through international tender and distributed throughout the country to farmers groups or cooperatives. Machinery is provided under a 7 year repayment agreement. 26. While these programs have encouraged international suppliers such as Claas and Ford/ New Holland to establish dealerships in Tbilisi and provided urgently needed machinery to the sector, suppliers see these as temporary solutions, which do not provide a long term foundation for the development of the machinery market in Georgia and may be undermine its long term development by crowing out the private sector. The challenge for government is now to stimulate the provision of private sector finance for machinery. b) Irrigation and Drainage The AAs operating the on farm systems are in danger of collapse. The financial status of the four LTDs operating the off-farm irrigation and drainage system is very fragile and plans to privatize them are premature. 27. Substantial investments have been made in irrigation and drainage infrastructure rehabilitation and the government is increasing its budget allocation for the system (to GEL 16. 5 million in 2009 or 37% of the MOA budget) but the institutional arrangements for management of the system are very fragile and water delivery is poor. vi 28. In the 2006, the government abolished the Department for Amelioration Scheme Management (DASM), which was responsible for management of the off-farm system and established four state-owned limited liability companies (LTDs), to which responsibility for operation of the primary and secondary (off-farm) systems was transferred. The LTD’s have struggled to arrange timely widespread delivery of water. LTD cost recovery through water fees is very low, averaging 13% in 2007 and the LTDs face high costs because of a requirement to build a 5% depreciation charge into their accounts and to pay tax on their property. The financial status of LTDs is therefore extremely fragile and government’s plans to privatize them in the near future appear to be premature. 29. Amelioration Service Cooperatives (ASC) were formed in 2001 to manage on-farm systems but were often poorly governed and characterized by poor financial accountability, rent seeking, and poor representation of the water users. In 2001, on the advice of the Bank, the government transformed ASCs into Ameliorative Associations (AAs), and amended the Law on Amelioration accordingly. 259 AAs were established covering 237,000 ha. In 2005, the government effectively withdrew support for the development of AA and consequently the majority of AAs are non-functional or very weak and are likely to collapse, unless water delivery from the LTDs improves and further management support is provided to them. c) Seeds The absence of a legal foundation and facilities for seed testing and certification has resulted in poor quality seed and undermined incentives for seed companies to invest. 30. The seed industry was deregulated in 2005 when the Georgian Government abolished the MOA State Commission of Testing and Protection of Selection Achievements and the MOA Seed and Seedling Quality Control Inspection. No alternative institutional arrangements have been set up since by the Government and consequently the seeds industry is largely unregulated. As well as affecting domestic production and undermining incentives for seed companies to invest, the absence of seed testing and certification systems means that Georgia is not able to sell seed in Europe. 31. The Law on the Marketing of Seeds and Planting Material of Agricultural and Vegetable and Vegetable Crop Varieties was amended in 2005 and 2006. There are no longer any requirements for the official testing of crop varieties to demonstrate their agronomic value through Value for Cultivation and Use (VCU) testing or to demonstrate their varietal purity and stability through Distinctiveness, Uniformity and Stability (DUS) testing. Consequently, varieties can now be freely marketed regardless of their likely performance. 32. While the Law of Georgia on Protection of New Varieties of Plants is aligned with the text of the International Union for the Protection of New Varieties of Plants (UPOV) and Georgia was granted membership of UPOV in 2008 and while the National Intellectual Property Centre is now responsible for granting Plant Breeders’ Rights to New Varieties in Georgia, the removal of articles relating to the requirement for a Georgian National Catalogue from the Seed Law, undermines the main purpose of this legislation. 33. There are no longer any measures in place for seed certification. The one seed testing laboratory which had been operated by the MOA Seed and Seedling Quality Control Inspection has closed and it is no longer possible to get seed tested in Georgia according to International Seed Testing Association (ISTA) seed testing methodology. vii d) Sanitary and Phytosanitary Control The government recognizes the importance of SPS control and it is an important aspect of preparation for the EU FTA. The National Service of Food Safety, Veterinary and Plant Protection (MoA) and the Division of Veterinary, Sanitary and Phytosanitary Control Organisation of the Department of Custom Control of the Revenue Service (MoF) appear to be poorly equipped to implement SPS control and further reform is required to align Georgian legislation with international standards. 34. The government recognizes the Importance of sanitary and phytosanitary (SPS) control, it features prominently in government strategy 1 and is an important element of preparation for the EU FTA. However currently, Georgia remains non-compliant with (a) its international obligations as a member of the WTO SPS Agreement; the International Plant Protection Convention (IPPC), the International Organization for Animal Health (OIE) and (b) the very large body of food, animal and plant health law applied by the European Union to imports from third countries. The principal consequences of this non-compliance are that: (i) Georgia does not apply international standards of health inspection and testing to imported foods, feed, veterinary medicinal products and plant protection products (of which it is a major importer), thus putting at risk the health and well-being of its human, animal and plant populations; and (ii) Georgia is unable to export processed foods and primary animal and plant products to the European Union Member States (its largest trading partner) and other WTO members. A number of institutional and legal weaknesses affect SPS control in relation to: i) food hygiene; ii) animal health; iii) veterinary medicinal products (VMPs); iv) plant protection and pesticides and v) animal by-products. 35. In 2005, government transferred responsibility for SPS inspection and control from MoA to the National Service for Food Safety, Veterinary Service and Plant Protection (the National Service or NS) but the NS is unable to perform these tasks effectively. The World Bank prepared an Action Plan for the NS in 2007 but most of the action points recommended in the Action Plan have not been implemented. Contrary to general EU practice, food, veterinary and phytosanitary controls at borders are entirely the responsibility of the Customs Service of the Revenue Service of the Ministry of Finance but it does not have the capabilities to undertake risk assessment or risk analysis or access to appropriate laboratory testing facilities. The Government has sought to transfer as much laboratory testing as possible to private laboratories but it still lacks policies and resources for their monitoring and accreditation. 36. The Government has suspended implementation of the inspection and registration powers provided by Articles 21 and 14 of the Law on Food Safety and Quality. The suspensions will end in January 2010 but the NS may not have enough technical inspectors and adequate skills to undertake inspection. Considerable investment and time will be needed before enterprises are compliant with international health and hygiene standards. As with certain countries, introducing licensing before EU Accession, it may be necessary to set approval standards at lower levels than currently applied by the EU, in order to avoid excessive closures and/or continued or increased non-compliance with the law. 1 Basic Data and Directions 2008. viii e) Marketing services Several donor projects provide good example of how to address weakness in marketing arrangements with small farmers and infrastructure for agricultural produce. 37. There are weaknesses in marketing arrangements for most commodities. These include the absence of well established marketing organizations, weak contractual arrangements between farmers; poor quality, packaging and grading; inconsistency in supply; poor post- harvest handling chains resulting in damage and waste; and inability to meet buyers’ requirements in terms of delivery schedules, contracts, timely delivery, and flexible payment terms. There is therefore, a need for both organizational support and finance for investment in physical infrastructure. 38. Several donor projects provide successful examples of how these constraints can be addressed. In the dairy sector, the SIDA dairy project has established milk collection and cooling facilities to help small farmers market their milk. In the fruit and vegetable sector, the USAID AGvantage project has established consolidation centres and provided finance and technical assistance to introduce improved processing, cooling and packaging technology for a wide variety of products. 39. The Russian wine embargo of has forced the wine sector to consider how to re-orientate itself towards new markets. The draft “Development of the Georgia Wine Strategy and Action Plan�, prepared under the World Bank Agricultural Development Project, identifies a comprehensive package of interventions to improve wine marketing, including measures to penetrate new mainly Asian markets, the establishment of a Wine Standards Board and a “National Wine and Brandy Making Bureau�, simplification of the appellations, long term investment in the technical aspects of viticulture and wine making, as well as investment in education in viticulture and winemaking. Rural Infrastructure 40. The 2006 World Bank report “Georgia, Rural Infrastructure in Georgia, Improving Service Delivery, Volumes One and Two� drew the following conclusions: while 98% of the population had access to electricity, availability was low with 32% of the population having less than 2 hours access per day; 21% of households had access to gas; 96% of households had access to potable water; 26% of communities had working telephone lines to houses; and the condition of roads in most communities was poor. 41. The 2006 study revealed that if communities’ ranking of the importance of alternative infrastructure investments is aggregated by region, the communities’ prioritize electricity, gas and roads and attach less importance to potable water, irrigation and drainage. However, more importantly, the study emphasized that there are differences in the priorities of different regions and differences between the priorities of different communities within each region, so that in some communities irrigation and drainage or potable water may be a first priority. 42. Ownership and management: The decision on whether public investment and ownership of infrastructure is appropriate should be based on whether the infrastructure provides an element of public good. Even in cases where infrastructure is publically owned, there may still be advantages in contracting out management to private service providers or delegating responsibility for management to community based organizations. ix 43. Willingness to pay for a various types of services and infrastructure is very high. For example households earning less than 100 GEL per month in 2006 and currently receiving less than 2 hours of electricity per day indicated that they were willing to pay up to 8 GEL per month for electricity, while households which were currently dependent on water vendors indicated a willingness to pay up to 25 GEL per month. 44. The report estimated the cost of basic rehabilitation of rural infrastructure at about US$1 billion at the time of the study, including US$212 million for lifeline roads, US$439 million for gas, US$87.3 million for electrification, US$46 million for telecommunications and US$ 47 million for potable water. Prioritization of Policy Challenges and Constraints 45. It is useful to consider which of these constraints represents the key limiting factors to growth of the rural economy. • Maintaining macro-economic stability is the first priority for government and will have a greater influence on growth of the rural economy than any individual rural development policy. Financial sector recovery following the financial crisis is the second priority for government. It is critical to overall economic recovery and increasing domestic demand for rural output. Maintaining a competitive exchange rate and trading arrangements in terms of tariff and non tariff barriers is important not only to farms and agribusinesses serving export markets but also to those competing on domestic markets, which are currently dominated by imports. • Rural infrastructure including electricity, gas, potable water, rural roads, telecommunications, is a major constraint which needs to be addressed to ensure basic human well being, to enable business to go about their daily operations, • Provision of Agricultural services is the next priority. a) Seeds: Insufficient importance has been attached to this constraint. It could be argued that this is the most important agricultural service constraint because without good seed, investments in agricultural services will not achieve their potential returns. b) Irrigation and Drainage: There is some urgency to address this issue, so that the condition of the system does not deteriorate further. c) Machinery Services: Now that government has rightly decided to cease the government machinery program, stimulating private sector financing is an urgent challenge. d) Sanitary and Phytosanitary Control: Establishing sanitary and phyto-sanitary services and regulation is important, not only to reach EU and other new export markets, but also because of the public health consequences of poor SPS standards. • Poor marketing infrastructure is a constraint but one which needs to be addressed through private sector sector. The provision of advisory services is not a limiting factor for farmers who do not yet have access to other basic services. Weaknesses in the land market are not a major constraint at the moment but it is important to prepare for evolution of a more active land market as and when demand for land increases. x 3. Policy Outcomes 46. This section examines the overall impact of the policies and constraints discussed in the previous section on the rural economy in terms of rural incomes, poverty and employment and in terms of structure and performance of the farm and non-farm sectors. The rural economy There is no evidence of rural urban migration or a shift of resources from the farm sector to the non-farm sector. 47. There is no evidence of migration from rural to urban areas as the rural population has remained relatively constant. There are no signs of a shift of resources from the farm sector to the non-farm sector. The private land market is not very active suggesting that there is no significant migration out of farming and the percentage of the workforce employed in agriculture has also remained fairly constant, declining from 54.9 percent in 2003 to 53.4 percent in 2007. Rural incomes have increased but this has mainly been due to increased public transfers, which has mitigated the impact of the poor agricultural performance on the rural population. 48. Increased public transfers have partly mitigated the impact of poor agricultural sector performance on the rural population. Rural monetary incomes (including public transfers) increased by 55 percent from 94 to 146 GEL per household per month (2007 constant prices) between 2003 and 2007. Agricultural wages increased from 112 to 126 GEL per month (2006 constant prices) or 12 percent between 2003 and 2006 but at a lower rate than wages in the economy as a whole, which increased from 160 to 198 GEL per month or 27%. Farm sector The government has considerably increased private ownership of land but farm structures have not changed significantly. 49. The package of agricultural reforms since 2004 has not brought about significant structural change for most of the farm sector. The second phase of land privatization resulted in an additional 14% of the total agricultural land area (excluding pastures) being transferred from state to private management under lease agreements and resulted in much larger than usual farm areas. However, the structure of the remaining 86% of the land area is largely unchanged. Limited structural change within the sector in terms of farm size and the very significant abandonment of land in 2006 2, is a strong indicator of the constraints and low profitability in the agricultural sector and of limited non-farm employment opportunities. This is supported by the static level of employment in the sector. The agricultural sector has not responded to macro-economic reforms and an improved business environment. Agricultural sector reforms have not improved agricultural productivity, which is stagnant. 50. The poor performance of the agricultural sector since 2003 and sharp contraction in agricultural output in 2006 has contrasted sharply with impressive growth in other sectors up until the global recession and the August 2008 war with Russia, which affected all 2 While the statistics show a significant decline in the cropped area, it is unclear how much of this change is due to a change of the methodology for data collection used by the Department of Statistics. xi sectors. Agricultural sector growth has been erratic (ranging between -8% and 12% averaging 1.3% between 2003 and 2008) but the low level of output, following the sharp decline in 2006, has been sustained. The decline in the sector in 2006 was consistent with a dramatic decline in crops areas and livestock numbers. Crops yields have been erratic but were particularly low in 2006. Low output and negligible migration of labor out of the sector are reflected in low and stagnant labor productivity in agriculture compared to other sectors. The agricultural sector has not been able to respond to the intense competition brought about by trade reforms because of weaknesses in basic agricultural services and infrastructure. 51. Georgia has found it difficult to compete with its trading partners in meeting domestic demand for beef, milk, fruit, vegetables and root crops. In the face of this competition, Georgia has managed to significantly increase its food and beverage exports from US$147 million in 2003 to US$249 million in 2007 but this success has been over-shadowed by much greater increases in imports of food and beverage which grew from US$182 million in 2003 to US$762 million in 2007. Georgia’s poor competitiveness is due to a combination of weakness in finance, agricultural services and infrastructure described in this report as well inequitable trade tariffs, particularly with Turkey as well as substantial exchange rate appreciation in recent years. Non-farm sector The government has been successful in stimulating the growth in the number of non-farm enterprises although growth has been concentrated in the trade sector. 52. Economic and trade reforms have lead to a substantial expansion of the non-farm sector. Enterprise numbers increased across the regions between 2003 and 2007 by an average of 126%, albeit with significant differences in growth in the regions which ranged from 26% to 215%. Growth has been greatest in trading enterprises (167%) although there has also been substantial growth in construction, real estate, transport and communications, hotels and restaurants and other types of business. 4. Recommendations for Reform 53. This section examines the extent to which policy makers should prioritize the farm and non- farm sectors and then presents some specific recommendations for reform in detail. A. Prioritization of Farm and Non-farm Sectors 54. In the short term, the priority is to increase competitiveness in the agricultural sector. This is because firstly, the rural economy is not well equipped to rapidly shift to the non-farm sector and secondly, because the demand for rural non-farm sector goods and services will primarily come from rural households, which are highly dependent on farm incomes. 55. The exposure of the agricultural sector to international competition following the trade reforms since 2005 will drive increases in efficiency but the government needs to put some basic foundations in place, including essential public services, to allow the agricultural sector to respond to this competition. 56. In the medium term, the rural non-farm sector can play an increasingly important role in the rural economy but this is unlikely to happen quickly and there is a need for diversification of the non-farm sector. xii B. Recommendations 57. The main recommendations can be categorised into five main areas summarized below. • Financial Services • Agricultural Trade • Rural infrastructure • Agricultural Services • Land Market 58. Table 28 prioritizes the recommended reforms. While many of the reforms can be implemented simultaneously and do not need to be sequenced, it is useful to recognize the relative importance of these reforms. Table 28 also summarizes implications of each area of reform for public expenditure; some will reduce public expenditure, some require only legislative changes and minor public expenditure, some require only some initial public investment and a declining public contribution to recurrent costs, while others require long term public funding. Table 1 Prioritization of Recommended Reforms and their Implications for Public Spending Recommendation Priority Public Public investment recurrent spending spending requirement requirement 1. Financial Services Provide a credit line to financial institutions for SME lending High High Low / short and loan restructuring ( including for leasing and machinery) term Amend the legislation on lease finance and taxation of lease Medium - - companies. 2. Agricultural Trade Examine opportunities to negotiate improved trade tariffs OF High - - trading partners. 3. Rural Infrastructure High / long term for Electricity, gas, roads, potable water, telecommunications High High government systems construction and rehabilitation and establish of owned public or community based ownership, management and Community financing arrangements. Specific Low / declining for community owned 4. Agricultural Services Further shift public spending away from private sector functions in the agricultural sector. Reallocate public spending to and further reform the legislative framework for, essential public services in the agricultural sector 4.1 Machinery services: Terminate the government High Medium - machinery program (as planned) and support private sector financing of machinery services through an existing or new credit line to financial institutions xiii 4.2 Irrigation and drainage off-farm system: Delay High High High / privatization of the LTDs and prepare the financial and declining regulatory aspects of a public private partnership with LTDs before privatization. Or maintain the LTDs under public ownership. Invest in rehabilitation of the off-farm system. 4.3 Irrigation and drainage on-farm system: Restart capacity High High Low / building of AAs and invest in rehabilitation of the on-farm declining system. 4.4 Seeds: Align legislation with EU marketing regulations. High Low Low Establish a national list of varieties. Invest in skills and facilities for VCU testing, DPU testing, seed certification and seed inspection. Aim to acquire ISTA and OECD seeds scheme membership in the medium term. 4.5 SPS: Align legislation with EU standards. Conduct NS Medium Low Low/ institutional reform in line with WB 2007 action plan. declining Establish laboratory testing and inspection capacity. 4.6 Veterinary services: Reform the law covering veterinary Medium High High/ service. Upgrade veterinary services in line with international declining OIE standards based on the OIE gap analysis. Establish disease control strategies. Invest in development of private vets and public services contracts with private vets. 4.7 Marketing services: Support replication of donor project Low Low Medium/ examples of supply chain development. Examine possible declining public investment to support the establishment of wine sector marketing organizations as outlined in the draft wine sector study, 2009. 4.8 Advisory services: Establish performance based public Low Low Low service contracts with private service providers for advisory services. 5. Land Market 5.1 Land title mapping: Identify those areas where there may Low Low Low be inaccuracies in mapping and where there may be substantial land market activity in future. 5.2 Land valuation: Develop skills and institutional Low Low - arrangements for land valuation 5.3 Maps: Produce comprehensive 1:10,000 maps as a basis Low Low - for land use and rural development planning 5.4 Land consolidation: Pilot and develop skills in voluntary Low Low - land consolidation 59. The recommendations are discussed below in detail except for rural infrastructure which is not addressed in depth in this report. 1. Financial Services Provide a credit line to private financial institutions for SME lending and loan restructuring 60. Examine the need for a line of credit from an international financial institution to commercial banks through the National Bank or MOF. Amend the legislation on lease finance and taxation of lease companies 61. Prepare for the future expansion of lease finance. This would contribute to the provision of private sector finance for machinery services. The requirement for leasing companies to xiv charge VAT on the interest portion of monthly installments from the lessee, needs to be re- examined. 2. Agricultural Trade Examine opportunities to negotiate improved trade tariffs with trading partners. 62. Re-examine the trade tariffs in the main countries with which Georgia trades agricultural produce. Identify opportunities to reduce trading partners’ tariffs or to increase quotas for preferential tariffs under free trade agreements. 3. Agricultural Services Further shift public spending away from funding of private sector functions in the agricultural sector 63. In 2009, fifty percent of the MOA budget is allocated to purchase machinery which is essentially a private sector function. The government should review its public expenditure program and shift funds previously allocated to the machinery program into other essential services discussed below. Reallocate public spending to and further reform the legislative framework for, essential public services for agriculture. 64. This will require substantial revisions to the existing public expenditure program in agriculture as well as some legislative reforms to provide essential public services discussed below. These reforms have implications for public expenditure: some will reduce public expenditure; some require only legislative changes and limited public expenditure; some require only some initial public investment and a declining public contribution to recurrent costs; and others require long term public funding. Machinery Terminate the government machinery program (as planned) and support private sector financing of machinery services, through existing or new credit lines to PFIs. 65. The government has rightly identified the lack of machinery as a key constraint in the agricultural sector but has addressed a failure in the financial market, through intervention in the machinery market. The government’s expected termination of the machinery program at the end of 2009 is well justified. The steps for reforming the machinery programs should be as follows: • Cease government provision of machinery [as planned]. • Transfer the budget from the government machinery program, to a government credit fund, to be lent through qualified PFIs. • Establish a credit line to qualified PFIs under the following terms:  Cease government provision of machinery (as planned).  Transfer the budget from the government machinery program, to a government credit fund, to be lent through qualified PFIs.  Establish a credit line to qualified PFIs, under the following terms: xv  The interest rate to the borrower should be equal to the prevailing market rate charged by PFIs, with any subsidies provided as matching grants.  The interest rate from the credit line to the PFI should not be lower than the basic rediscounting rate of the central bank (the bank rate) or the average cost of savings deposits in the economy.  The government should aim for an arrangement whereby the PFI assumes 100% of the risk, although if this is not possible, temporary arrangements for government to share the risk could be established.  Gradually phase out the credit line as liquidity in the financial sector improves. • A preferable alternative would be to have a non-targeted credit line which farmers and agribusinesses can access for a variety or working capital and investments needs. Irrigation and Drainage Off farm system: Delay privatization of the LTDs and prepare financial and regulatory aspects of a public private partnership with LTDs before privatisation, or, maintain the LTDs under public ownership. Invest in rehabilitation of the off-farm system. On-farm system: Restart capacity building of AAs. Invest in rehabilitation of the on-farm system. 66. The government plans to privatize the four LTDs operating the off-farm irrigation and drainage system within the next few years and should consider the following points: • Some form of public private partnership (PPP) may be more appropriate than outright privatization. One option would be a PPP agreement, whereby the state maintains ownership of the system and grants a private operator the right to operate and profit from the system, under conditions, including minimal investment, limits on water charges and minimum standards of services. • Some package of public funding for rehabilitation of the system and arrangements for regulation will need to be in place before privatization, if the four entities which emerge from privatization are to be financially viable and the AAs are to be protected against their potentially monopolistic behavior. • Development of the AAs will be a pre-requisite to successful privatization or indeed continued public management of the system. If there are no viable AAs, the LTD would have few clients. Seeds Align legislation with EU marketing regulations. Establish a national list of varieties. Invest in skills and facilities for VCU testing, DPU testing, seed certification, and seed inspection. Aim to acquire ISTA and OECD seeds scheme membership in the medium term. 67. Poor seed quality is a major cause of low productivity. Key reforms should include the following: i. Amend the seeds law to require national listing of varieties, testing and certification. Align supporting regulations with EC Seed and Planting Material Marketing Directives. ii. Establish capacity in the National Service for laboratory testing and field inspection and inspection capacity at the borders. xvi iii. Examine options for management and financing for seed certification and testing system, which may include a voluntary or compulsory scheme iv. Aim to acquire International Seed Trading Association (ISTA) certification in 3 years and OECD certification in 5 years. v. Remove the VAT on seeds, to remove the incentive for traders to avoid VAT by importing seed as feed, which creates unfair competition for legal traders. Sanitary and Phytosanitary Align legislation with EU standards. Conduct reform of the National Service in line with WB 2007 action plan. Establish laboratory testing and inspection capacity. 68. In order to gain greater access to EU and other markets and to protect public health, SPS standards should be aligned to EU standards and National Service for Food Safety, Veterinary Service and Plant Protection (the “National Service or NS) capacity developed in line with the recommendations of the Bank’s 2007 Action Plan for the National Service. This program requires legislative reform and public funding. Key reform priorities include: i. Termination of the suspension of Article 14 of the Food Law, completion of registration of enterprises (as planned) and allowing inspection of enterprises handling food by inspectors. ii. Alignment of plant health and plant protection legislation with EU standards. iii. Establishment of capacity for laboratory testing of food products and agricultural chemicals and examination of options for private sector involvement in management and financing of these services. Veterinary Services Reform the law covering veterinary service. Upgrade veterinary services in line with international OIE standards based on the OIE gap analysis. Establish disease control strategies. Invest in development of private vets and public services contracts with private vets. 69. The International Organization for Animal Health (OIE) is expected to undertake an evaluation of the animal health service in Georgia which is expected to provide a gap analysis. This would provide a strategic plan for investment to upgrade the service to a satisfactory level in accordance with the WTO and international standards. 70. The strategic plan would provide plans for control of contagious diseases including, development of national animal disease information systems, disease surveillance systems, laboratory testing capacity, and comprehensive vaccination programs. 71. As well as measures to control contagious diseases, the OIE recommendations are likely to include legislative and institutional reforms to promote the development of private veterinary services, including the licensing, supervision and training of private vets. Marketing and Advisory Services Establish performance based public service contracts with private service providers for advisory services. 72. There is a need to improve technology transfer to farmers and agribusinesses. At this stage, rather than establishing a national extension service, the government could contract NGOs and agricultural service centres with relevant experience to provide these services. xvii 73. An alternative model would be to provide funding directly to community based organizations, which would be established to procure services on behalf of its members similar to the model currently being developed in Kyrgyzstan. Support replication of donor project examples of supply chain development. Examine possible public investment to support the establishment of wine sector marketing organizations, as outlined in the draft wine sector study, 2009. 74. While investment in private marketing services, including storage, cooling, grading and transport facilities particularly for citrus, fruit, vegetables and livestock products, can best be undertaken by the private sector, there is considerable experience amongst donor projects in supporting supply chain development, which could usefully be demonstrated to private investors. 4. Land market 75. There are a number of measures which could be undertaken to help prepare for stronger demand for land in future, as follows: a. Systematically verify the legality of land rights documents and accuracy of cadastral maps and reissue these where necessary where there may be substantial land market activity in future. b. Develop skills and institutional arrangements for land valuation. c. Produce comprehensive 1:10,000 maps as a basis for land use and rural development planning. d. Pilot and develop skills in land consolidation. Consolidation will eventually take place through market transactions. However, there may be cases where government facilitated land consolidation would allow certain rural developments to take place. Conclusion 76. The recommended reforms will help to promote equitable growth in the rural economy. Further design of each of the proposed reforms should include intensive consultation with the private sector and examination of opportunities to involve the private sector in financing and managing services. Reforms should also be designed to ensure that any regulation does not create barriers to entry of new businesses or create opportunities for corruption, a challenge which Georgia has successfully dealt with in many other areas of the economy. xviii I. INTRODUCTION 1. Georgia’s program of economic reforms since 2003 resulted in impressive economic growth and an improved business climate up until the recent global financial crisis. The rural economy has not responded to the improved economic environment to same extent as the urban economy and there is growing inequity between rural and urban incomes. This is of particular concern given that almost two thirds of the population is employed in the rural economy and there are few signs of rural-urban migration. The purpose of this report is to examine the characteristics of the rural economy, assess the policy framework within which the farm and non-farm sectors operate, assess the outcomes of policy reforms since 2003 and identify reforms to stimulate growth of the rural economy. 2. The report is structured as follows. Section I examines the contribution of the rural economy to the national economy, the structure of the farm and non-farm sectors and their relative importance. Section II describes policies and constraints affecting the wider rural economy including, reforms in macro-economic management, recent external influences and financial services before discussing those which relate specifically to agriculture including, agricultural trade policy, land reform, agricultural machinery services , irrigation and drainage, seeds, sanitary and phytosanitary control and veterinary services, marketing and advisory services. Section III assesses the outcomes of these policies on the structure and performance of the rural economy. Section IV describes the extent to which policy makers should prioritize the farm and non-farm sectors in rural areas and then presents recommendations for reform. While it is recognized that rural infrastructure (roads, potable water, energy) and rural social services have a major impact on the rural economy, the report does not attempt to address these issues in detail. Rural Infrastructure issues are examined in “Rural Infrastructure in Georgia, Improving Service Delivery� (World Bank, 2006) and key findings of this report are summarized at the end of section II. 3. The team undertook a mission to Georgia in March 2009. The report is based on consultation with and data provided by the government, numerous donor projects working in rural development in Georgia (funded by European Commission, USAID, USDA, SIDA, CARE International) and the numerous representatives of the private sector including, famers, commercial banks, microfinance organizations, machinery businesses, agricultural input suppliers and agro-processors. The report draws on several key sources of information including: the Poverty Assessment Report (World Bank, 2008), which is based on the Household Budget Survey (HBS) from 2003 to 2006, and the 2007 Living Standards Measurement Survey (LSMS); the Ministry of Economic Development Department of Statistics Yearbook 2008, Enterprise Survey 2003-2006, Enterprise Survey 2007 and Small and Medium Business in Georgia Survey 2008; data on public spending provided by the Ministry of Finance; and data from a series of aide memoires on the World Bank Irrigation and Drainage Community Development Project (IDCDP). 1 II. STRUCTURE OF THE RURAL ECONOMY A. The Rural Economy Rural Population 4. Georgia is only moderately urbanized. Georgia’s urban population are concentrated in Tbilisi where 25% of the population live 3, five large towns with populations of over 50,000 each where 14% of the population live, and a further 56 smaller towns with populations of less than 50,000 where a further 14% of the population live. Half of the smaller towns have populations of less than 10,000 people. The remaining 47% of the population live in smaller rural settlements. The rural population density is greatest in the valleys running through the centre of the country and along the coast and lowest in mountainous regions. While agricultural production is located in rural areas, many of the upstream and downstream businesses serving the agricultural sector are located in urban areas. The regional distribution of the population is shown in Figure 2. Figure 2 Regional Distribution of the Population Source: Statistical Yearbook 2008 Rural employment, wages and sources of income 5. The majority of the population is employed in the rural economy which employs 65 percent of the total workforce. Of these, most work in the agricultural sector, which employs 53 percent of the total workforce 4, including, self-self subsistence farming and paid labor, which is employed at wages of less than 50 percent of average national wages. Agriculture is dominated by self-subsistence farming which accounts for 73 percent of total rural employment. The other 12 percent of workforce which work in rural areas are employed in the rural non-farm sector. While there is no disaggregation of non-farm employment in urban and rural areas, nationally, non-farm sector employment is dominated by employment in trading enterprises. Other important sources of employment are the education sector, manufacturing, public administration, transport and construction. There are significant differences in wages between non-farm sectors, with those involved in the public administration, construction and transport, earning more than double those 3 The total population of Georgia in 2008 was 4,382.1 million. 4 This figure includes agriculture, hunting and forestry but the vast majority of this employment is likely to be in agriculture. 2 employed in agriculture, while those employed in health, social work and education, earn a similar wage to those employed in agriculture (Table 2). Differences in rural and urban wages for a particular sector such as construction are not clear. Overall, urban wages are 43% more than rural wages 5. Table 2 National Employment and Wages by Sector Source: World Bank estimates using 2003 and 2006 Household Budget Survey data in WB Poverty Assessment 2008 6. Overall, subsistence agriculture is the main source of income for rural households, although there are significant differences between income groups. Rural incomes averaged GEL 261 per month in 2007 with considerable inequity between income groups (Figure 3). In 2007, subsistence agriculture accounted for 41% of income, mainly in the form of in-kind own consumption. The contribution of various sources of income for each income groups is shown in Figure 4. Low income households (Q1) are highly dependent on public transfers (social assistance and pensions) which represent 55.2% of total income and less so on farm income (farm produce sales plus the value of in consumption of own produce), which represents 27.2% of total income. High income households (Q5) generate 42.6% of their income from farm production, 40.4% from salary, wage and self employment incomes and only 8.7% from social transfers. The middle income groups (Q2-Q4) generate 39% of their income from farm production, 27% of income from salary, wage and self employment incomes and 27% from public transfers 6. Remittance incomes were reported by a low 3.7 percent of rural households, and accounted for only 1.1 percent of total household income. Higher-income households (Q5) benefited most from remittances in 2007 and low-income households (Q1–Q2) the least. 5 LSMS in Poverty Assessment 2008, WB. 6 The population is divided into five income quintiles Q1-Q5. This is the average of Q2, Q3 and Q4 3 Figure 3 Rural Incomes 2007 Source: Poverty Assessment Report, 2008 Figure 4 Composition of Rural Income in 2007 Source: Poverty Assessment 2008, World Bank Rural Poverty 7. Rural poverty rates remain markedly higher than urban poverty rates but vary considerably depending on a variety of household characteristics. Consumption-based rural poverty remains high, with 29.7 percent of rural population below the total poverty line and 12.4 percent below the extreme poverty line in 2007, in contrast to 18.3 percent and 6.7 percent 4 respectively in urban areas. 7 In 2007, the rural poor accounted for 59 percent of all poor in Georgia. The World Bank Poverty Assessment Report 2008 conducted multi-variant analysis to estimate which household characteristics determined the level of poverty or extreme poverty. The analysis revealed that the risk of poverty was greatest for: a) households of which the head did not have formal employment; b) households whose head is self- employed in agriculture; c) households with a low level of education; d) female headed households; e) high dependency ratio households (i.e. ratio of non working to working members in the household), implying that those with more children were poorer and; f) households located in certain regions. Differences in geography, proximity to major markets and transport routes and political stability, result in two broad zones of economic well-being in rural areas. The wealthiest regions, with the lowest levels of rural poverty, lie in a continuous arc running from Samegrelo in the northwest to Kvemo Kartli in the southeast. The poorest regions form a second continuous arc along the fringes of the mountains that form the northern border with Russia 8. Poverty rates in Tbilisi and each of the regions is shown in Table 3. The combination of these influences, results in rural poverty rates which vary which from 13% to 59% in the regions. Table 3 Poverty in Tbilisi and the Regions Source: Poverty Assessment 2008, World Bank Rural Output and Investment 8. The contribution of the rural economy’s output is lower than its share in employment mainly because of low labor productivity in the agricultural sector. In 2007, 10% of total output was generated by the farm sector and 90% by non-farm sectors. According to the Department of Statistics 2007 enterprise survey, (described further in para. 19) 36% of non-farm output was estimated to be generated by the non-farm sector in the regions, 20% of which (7.2% of non-farm output or 6.5% of total output) was generated by small and medium enterprises. Using SMEs in the regions as a proxy for rural non-farm enterprises 9, it is estimated that in total, the farm and rural non-farm sectors generated something less than 16.5% of total output in 2007 but employ more than 65% of the population. Labor productivity in the farm sector appears to be very low compared to the non-farm sector, employing 53% of the total workforce and generating only 10% of output. This is consistent 7 Poverty Assessment Report 2008. These are estimates of absolute of poverty, based on a poverty line of 71.6 GEL per adult equivalent per month for all basic necessities, and an extreme (food only) poverty line of 47.1 GEL per adult equivalent per month—sufficient for daily food consumption of 2,260 calories. 8 Rural Poverty Assessment (World Bank 2008) 9 See explanation in para. 15 5 with the low level of investment in agriculture. Agricultural lending represented less than 1% of banks’ loan portfolios and foreign direct investment (FDI) in agriculture was less than 1% of total FDI in 2007 10. B. Structure of the Farm Sector Agricultural Land Area 9. Agricultural land represents about 42 percent of the Georgia’s land area of which 59 percent pasture land, 26 percent is arable land, 9 percent perennials and 5 percent meadows (Figure 5 ). Georgia’s relief is largely mountainous with heights between 0 m (Black Sea) and 5,201 m (Mt'a Shkhara), with the Great Caucasus in the north and the Lesser Caucasus in the south, Kolkheti Lowlands opening to the Black Sea in the west and the Mtkvari River Basin in the east (Table 4). During the Soviet period, infrastructure was built to irrigate 469,000 ha (Eastern and Central Georgia) and drain 163,000 ha (Western Georgia) 11. Large parts of these systems are non-functional or only partially functional. Figure 5 Land Area (ha) Forestry lands, 1730 2,384 771 Agricultural 255 Water fund lands, 2,914 138 lands, 805 20 homesteads arable lands meadow s perennials pastures Non-agricultural lands, 867 Table 4 Land Altitude 2 Altitude band (m) Area (km ) 0 ÷ 500 18,200 (26%) 500 ÷ 1,000 13,900 (20%) 1,000 ÷ 2,000 24,100 (35%) 2,000 ÷ 5,201 13,500 (19%) Land Ownership and Farm Size 10. At the end of 2008, 929,000ha or 32 percent of all agricultural land (2,914 thousand ha) or 78 percent of all agricultural land excluding pastures, were under private ownership. This was the result of the first phase of privatization which started in 1992, under which 761 thousand ha of agricultural land were privatized with an average plot size of 0.25 ha or 0.94 ha per household and the second phase of land reform which started in 2005, under which 162.5 thousand ha of state land, which had been leased out, were privatized with an average plot size of 12.5ha. Additionally, 5.7 thousand ha with an average lot area of 186 ha was privatized under the Agro 100 program. Pastures are currently being transferred from central government to local government. Pastures under the ownership of state cattle 10 National Bank of Georgia Bulletin of Monetary and Banking Issues 11 th IDCDP World Bank Aide Memoire April 30 2008 6 breeding farms will be sold or leased out. The government aims to divest of most state owned agricultural land, except pastures and a 5km wide security strip along Georgia’s borders. A further 464 thousand ha of agricultural land, which is currently leased from the state or unused, is targeted for privatization. The land privatization process is described further in para. 58. 11. Georgia has a relatively low endowment of agricultural land. Following the land privatization described above, agriculture is dominated by smallholder subsistence farms with an average land area of 1.2 ha per farm holding. Approximately 40 percent of farmers have less than 0.5ha of land, 53 percent have between 0.5 ha and 2.0 ha and a further 6 percent have been 2.0 ha and 10ha, typically divided into 1-3 plots per farm (average 2.3 plots) as shown in Figure 6. While there are some production cooperatives and farming companies, the vast majority of land is farmed by individual families and there are currently about 728,000 agricultural holdings in the country. Figure 6 Number of Holdings by Farm Size (2004) Source: Agricultural Census 2004 Cropping and Livestock Structure 12. About 54 percent of agricultural output is generated from crops and 46 percent from livestock 12. Georgia’s eight main climatic zones are determined by their distance from the Black Sea and Altitude. The West (Samegrelo Zvemo, Guria and Adjara) is dominated by maize, tea, orchards and citrus; the central west (Racha Lechkhumi Kvemo Svaneti and Imerti) by maize, vineyards and vegetables; the central east (Samtskhe-Javakheti, Shida Kartli, Mtskheti Mtianeti, Kvermo Kartli) by wheat, maize, fodder, potato and vegetables; and the east (Kakheti) by vineyards, sunflower, wheat and maize. The dominant cropping in each region is shown in Figure 8. The livestock sector is dominated by cattle which are widely spread across all regions. Sheep production is mainly concentrated in the Kakheti and Kvemo Kartli, Mtskheta-Mtianeti, Samtskhe-Javakheti (Figure 7). The outbreak of African Swine Fever in 2007 severely reduced the pig population, especially in Samegrelo, Guria, Mtskheta-Mtianeti and Kakheti regions. 12 Statistical Yearbook 2008 7 Figure 7 Distribution of Livestock by Region Source: Statistical Yearbook 2008 8 Figure 8 Cropping by Region Source: Statistical Yearbook 2008 9 C. The Structure of the Non-Farm Sector 13. In assessing the characteristics of the rural non-farm sector, the Ministry of Economic Development (MED) Department of Statistics data on registered Small and Medium Enterprises (SME) in the regions are used as a proxy for the rural non-farm sector, based on the following: • Data on registered enterprises does not specifically distinguish between rural and urban businesses but does distinguish between businesses based in Tbilisi and those in the regions. • The majority of the 728,000 farm holdings are small and do not register as enterprises, so the data essentially represents the non-farm sector. • The majority of large enterprises in the regions are likely to be based in urban settlements, so using SMEs as a proxy, excludes a large part of non-farm activity in urban settlements in the regions. • On one hand, using registered SMEs in the region as a proxy for rural non-farm activity over- states rural non-farm activity, because some registered SME in the regions operate in urban settlements. • On the other hand, using registered SMEs in the region as a proxy for rural non-farm activity under-states rural non-farm activity, because many SMEs are not registered. 14. Nevertheless, this approximation provides the best indication of rural non-farm sector activity given the limitations of the data and provides a basis for assessing trends in rural non-farm sector development. 15. The MED Department of Statistics publication, Entrepreneurship in Georgia 2008 provides the following information on all registered enterprises disaggregated by region and Tbilisi City. • Number of enterprises (small, medium and large) • Ownership of enterprises (private or state) • Legal form (individual or legal entity) • Business Activity (trade, manufacturing, services etc.) The key conclusions from this data follow. 16. Number of enterprises: There were a total of 207,598 registered enterprises (in Tbilisi and the regions) in 2007, about 51% of which are located in the regions (Table 5). The three largest regions in terms of enterprise numbers are Imeriti, Kvemo Kartli; and Samegrelo- Zvemo Svaneti. The number of enterprises per capita in each region does not appear to be strongly linked to the wealth of the region. The poverty characteristics of the regions, was discussed in para. 7. The number of enterprises per capita in the regions averages about 32 per 1,000 head but ranges from 42 to 21 with a similar level of variation between regions with similar levels of poverty (Table 5). 10 Table 5 Number of Registered Enterprises by Region Source: Adapted from Entrepreneurship in Georgia 2008, MED, Department of Statistics 17. Enterprise ownership: The vast majority of all enterprises are privately owned. The majority of enterprises are registered by individuals rather than as legal entities. In 2007, approximately 98.8 percent of registered enterprises were privately owned and the rest (1.2 percent) were state owned. 71 percent of enterprises were registered as individual entities and the remaining enterprises as limited liability companies (26 percent) and other categories of legal persons, including, joint liability companies, limited partnerships, joint stock companies and cooperatives (3 percent) (Table 6). Table 6 Registered Enterprises by Type of Ownership, 2007 Source: Entrepreneurship in Georgia 2008, MED, Department of Statistics 18. Enterprise business activity: The majority of enterprises in 2007 were trading enterprises. By business activity, trading enterprises dominate in terms of numbers (76.7 percent), followed by manufacturing (6 percent) and transport & communications (3 percent) (Table 7). The recent MED Department of Statistics publication, Small and Medium business in Georgia, 2008, provides additional information on the nature of trading and the importance of domestic and export markets. Of the trading enterprises which dominate the SME 11 sector, nearly 40 percent of those surveyed, deal basically in imported goods, 21.6 percent deal only in imported goods and 8.5 percent deal only in locally produced goods. In Q4 2008, most of the surveyed SMEs (73.5 percent) sold their production on local (internal) markets while only 2.9 percent of SMEs sold their products in external markets. Table 7 Number of Registered Enterprises (small, medium and large) by Business Activity, 2007 Source: Entrepreneurship in Georgia 2008, MED, Department of Statistics 19. The Department of Statistics 2007 enterprise survey described in Entrepreneurship in Georgia 2008 report provides insights into the likely distribution of enterprises by small, medium and large enterprises and their respective contributions to enterprise turnover. The survey results are disaggregated by region and Tbilisi City 13. The number of enterprises surveyed in 2007 was 23,137 including 100 percent of all large enterprises (1,516); and about 10 percent of all registered small and medium enterprises (i.e. 10% of 206,082). 20. Estimated enterprise size: The survey data on enterprise size is shown in Table 8. This data has been extrapolated to estimate the number of small, medium and large enterprises in each of the regions (Table 9). The estimation suggests that the majority of registered enterprises in the regions are small (93,111 or 89 percent); followed by medium enterprises, (11,478 or 11 percent); and large enterprises, (519 or 0.5 percent). The estimation also suggests that over 50 percent of all SMEs (over 100,000 registered enterprises) are located in the regions (Table 10). Table 8 No. of Small, Medium and Large Enterprises in the 2007 Enterprise Survey Source: Entrepreneurship in Georgia 2008, MED, Department of Statistics 13 One of the methodological problems in the survey results is that the surveyed enterprises (23,137) report their operations with reference to the location of their respective head offices and there is no region-wise break-up of the enterprises’ operational data available in the survey results. 12 Table 9 Estimated Numbers of Small, Medium and Large Enterprises by Region as of Dec. 2007 Source: World Bank estimate based on extrapolation of data from Entrepreneurship in Georgia 2008, MED, Department of Statistics. Table 10 Estimated Regional Distribution of Small, Medium and Large Enterprises as of Dec. 2007 Source: World Bank estimate based on extrapolation of data from Entrepreneurship in Georgia 2008, MED, Department of Statistics. 13 Enterprise turnover 21. Registered SMEs are estimated to generate about 25 percent of all registered enterprise turnover in the regions. The 2007 survey indicated that of the total turnover of the 23,137 enterprises surveyed, at GEL 17.5 billion, 5 percent (933 million) was contributed by small enterprises, 9 percent (GEL 1609 million) by medium enterprises and as much as 86 percent (GEL 15,002 million) by large enterprises (Table 11). Of this, about 57 percent of small enterprise turnover and 44 percent of medium enterprise turnover is generated in the regions, compared to only 24 percent of large enterprise turnover (Table 12). Of the total turnover of enterprises surveyed in the regions, 11 percent is generated from small enterprises, 14 percent of from medium enterprises and 75 percent from large enterprises (Table 11). Table 11 Contribution of Small Medium and Large Enterprises to Total Enterprise Turnover in the Regions 2007 Source: Entrepreneurship in Georgia 2008, MOED, Department of Statistics Table 12 Regional Contribution of Tbilisi and Regional Enterprises to Total Enterprise Turnover 2007 Source: Entrepreneurship in Georgia 2008, MOED, Department of Statistics 22. Enterprise employment: The recent MED Department of Statistics publication, Small and Medium business in Georgia, 2008, showed that in terms of employment, trading enterprises are the largest employers (about 20 percent of employment); followed by manufacturing (14-16 percent); health and social services (13-14 percent); real estate (13 percent) and construction (9 percent). 23. This section has reviewed the structure of the rural economy. In conclusion, land privatization is well advanced but the rural economy is characterized by stagnant subsistence agricultural and a vibrant but narrow non-farm sector dominated by trading activity. The poorest sections of society remaining highly dependent on public transfers. 14 There are however, great regional differences in terms of the nature of agriculture and the extent of rural poverty. The next section examines policies affecting the rural economy and constraints faced by rural businesses. Text Box 1: SME Definition The Government of Georgia’s Statistical Year Book currently uses the following definition/s to classify registered enterprises as small, medium and large: Small Enterprises: No. of employees 20 or less and/or turnover of GEL 500,000 or less; Medium Enterprises: No. of Employees: >20 but <50 and/or turnover less than GEL 1.5 million and Large Enterprises: No. of Employees >50 and/or turnover greater than GEL 1.5 million. This definition is incorporated in the Law on National Investment Agency of Georgia but not in the Law on Entrepreneurship in Georgia which is designed to regulate the business sector as a whole, including SMEs. Prior to the 2006 amendment, the original Law on National Investment Agency of Georgia, which became operational in 2002, defined enterprises with annual turnover of less than GEL 100 thousand as SMEs, with enterprises employing up to 10 persons considered as small and those employing up to 40 persons as medium. There is a view in Georgia that the expanded scope of the new SME definition should be narrowed down, using profit rather than turnover as the criterion. The underlying rationale for the current government definition of SMEs is unclear and its efficacy as a targeting mechanism is debatable. It could be argued that it is important to improve the investment climate for all categories of enterprises, including SMEs, and that there is no the need for any formal definition of SMEs, given that SMEs with a taxable income of GEL 100,000 or less are already exempt from VAT and given that there are no other major subsidy programs now in place for the SMEs. However, the rural economy is dominated by SMEs which have specific problems, not least in accessing finance. While the government priorities for 2009 include support of SME, this target group may be too large to effectively focus government assistance to smaller SMEs and achieve the intended objectives. The situation is exacerbated by the fact that Georgian commercial banks and MFIs have their own and more liberal definitions of SMEs relative to the government’s definition, based mainly on the size of the loan. The government needs to clarify its position on SME definitions used by the government, commercial banks and MFIs, in terms of their purpose/rationale and explore how it will ensure that any special financial or technical assistance programs are targeted to the desired group of SMEs. The IFC 2006 Analytical Report on Business Environment in Georgia noted that “because Georgian businesses are not tracked by size, it is impossible to understand exactly what share of operating Georgian enterprises are SMEs and how these firms contribute to production and employment. This likewise makes it impossible to compare enterprises in Georgia with those operating in European and CIS countries. An essential step to underline the government’s intent to support the growth of small business would be the development and publication of basic statistics on SMEs, as is done in European countries and increasingly in CIS countries�. 15 III. POLICY FRAMEWORK AND CONSTRAINTS 24. This section describes government policies and key constraints affecting the wider rural economy including, reforms in macro-economic management, recent global and regional influences and the financial sector. It also reviews agricultural trade policy, land reform, public expenditure in agriculture and agricultural services including, agricultural machinery services, irrigation and drainage, seeds, sanitary and phytosanitary control and veterinary services and marketing and advisory services. A. Macroeconomic Management 25. The government has established a relatively strong macro-economic environment. Annual inflation was contained between 6 percent and 9 percent, until 2007 when it rose to 11 percent as global commodity prices and capital inflows increased. Inflation has decline from 9 percent in January 2009 to 2.2 percent in October 2009 and is projected to be 1.2 percent in 2009 and 3 percent in 2010. The budget deficit was contained to below 3 percent until 2006 due to improved revenue collection before rising to over 4 percent due to increased social and infrastructure spending. The Central Bank has implemented a managed floating exchange rate, intervening in the foreign exchange market when necessary to maintain foreign reserves, while attempting to prevent excessive appreciation and erosion of competitiveness. As a result of massive foreign direct investment in the Baku-Tbilisi-Ceyhan pipeline and large injections of foreign aid, capital net inflows reached 87 percent of GDP and the trade deficit reached 173 percent in 2007. Exchange rate appreciation has eroded the competitiveness of agricultural exports and made imported food more attractive. 26. The success of the reform program is evidenced by impressive economic growth which increased from 5.9 percent per annum in 2004 to 12.4 percent in 2007, before declining to 3.5 percent in 2008 following the war with Russian and the global recession. Growth is projected to be -4 percent in 2009 and 2 percent in 2010. An improved business climate has increased foreign direct investment (FDI) which increased from 8.4 percent of GDP in 2003 to 16 percent in 2007 before declining sharply in 2008. This success has been mirrored in the rural non-farm sector but not in the agricultural sector, which has grown at an average of -1.3 percent per annum between 2003 and 2008, suggesting that weakness in the agricultural reform program need to be addressed. B. Recent Global and Regional Influences 27. Against this background of responsible macroeconomic management, a number of external factors have had a substantial impact on the economy as a whole. These are summarized below and discussed further in the relevant sections. • The 2006 Russian trade embargo: While the import ban by Russia primarily affected higher value agricultural products such as wine, mineral water and vegetables, the negative impact on the economy as a whole may have reduced domestic demand for all types of agricultural produce, resulting in a severe contraction in cropping as discussed in section IV. The wine sector was a particularly badly affected by the loss of its traditional market, although it is now adapting to serve new markets. 16 • The financial crisis and global economic recession: The global financial crisis of 2008, ignited by the sub-prime mortgage crisis in the US in 2007, resulted in a sharp contraction in lending, not least to small rural businesses, as described further in section IIIC. The crisis was exacerbated by the banks’ high dependence on foreign borrowings and a draw on deposits following the August 2008 war with Russia. The wider economic recession which followed, depressed both foreign and domestic demand for Georgian products and arrested the previously burgeoning growth of trading activity, which dominates the rural enterprise sector. • The food crisis: The global increase in food prices in 2007 and 2008 created net benefits for larger farmers who were net producers of food, although this was moderated by higher fuel and input prices driven by high oil prices. In contrast, the food crisis negatively affected the majority of rural households, which are net consumers of food. The impact of the crisis on net food consumers was moderated to some extent by the high exchange rate, which made food imports, on which Georgia is highly dependent, cheaper in Lari terms. • The August 2008 war with Russia: As well as the human losses, displacement of the affected population, damage to infrastructure and loss of agricultural output 14 in the areas affected by the war over South Ossetia, the war also had a wider economic impact. It dented investor confidence, caused a draw on bank deposits, further eroding banks’ ability to lend, reduced public revenues and necessarily diverted public funds to the recovery effort. The construction, real estate, retail and tourism sectors were particularly badly hit 15 creating job losses and reduced consumer demand. 28. The study now looks at some of the specific policies and constraints affecting the rural economy. C. Financial Services 1. Banks Structure of the Banking Sector 29. Commercial banks dominate the financial sector and Georgia’s banking sector. Commercial banks account for 83 percent of the financial system’s total assets at GEL 10,649 million or 56 percent of GDP as at the end of 2008. The banking sector is highly concentrated. Two banks (Bank of Georgia and TBC Bank) dominate the sector along with about six medium- sized banks (Bank Republic, ProCredit Bank, Cartu Bank, VTB, Peoples’ Bank, Tao Private Bank), which together account for more than 90 percent of the banking system’s total assets. Table 13 shows the combined balance sheets of the commercial banks in the years 2006 and 2009. 14 The Joint Needs Assessment estimated that about 40,000 smallholders in the Gori plain were affected. 15 Source; Summary of Joint Needs Assessment Findings, 2008, United Nations/ World Bank. 17 Table 13 Georgia’s Commercial Banking System (End of period) Type of Financial Institution 2006 2007 2008 March 2009 Commercial Banks No. 17 19 20 20 Of which no. of foreign controlled banks 12 14 17 17 Commercial Banks’ Total Assets (GEL million) 4,227 7,208 8,865 8,241 of which, net loans (GEL million) 2,586 4,425 5,454 5,067 as percent of financial system’s total assets 68.2 83.5 83.2 -- as percent of GDP at current prices (Note 1) 44.9 50.7 55.8 ..-- Com Banks’ Total Liabilities (GEL million) 4,227 7,208 8,866 8,240 Com Bank’s Non-Bank Deposits 2,097 3,215 3,567 3,105 Com Banks’ Borrowed Funds 854 1,942 3,174 2,983 Com Bank’s Equity 898 1,471 1,571 1,495 Other Indicators No. of banks per 100,000 population 0.39 0.43 0.46 0.46 No. of branches 122 124 124 121 No. of Service Centers 298 416 569 550 No. of Exchange Bureaus 655 806 1030 1111 Note 1: (excl. insurance companies and pension funds) Source: National Bank of Georgian Statistical Bulletin of Banking and Monetary Statistics 2008 Performance of the Banking Sector and Impact of the Financial Crisis 30. The financial crisis arrested the previously impressive growth in the financial sector and reduced the availability of credit to SMEs. Commercial banks have aggressively expanded credit provision in recent years (Figure 9). Credit growth outpaced deposit growth and growth in lending was largely funded by foreign bank loans and capital market borrowings. 31. Lending has contracted in the wake of ongoing global economic slowdown. The rate of growth in commercial banks’ assets has not only slowed down but is expected to contract during 2009 and the percentage of loans which are overdue has increased (Figure 10). Of the 20 commercial banks currently operating in Georgia, 17 are foreign controlled (including 2 branches of non-resident banks) and much depends on how much more risk the owners of these foreign banks will take in Georgia as long as the prevailing economic slowdown continues. 32. According to the recent IMF report (January 2009), the financial soundness indicators of commercial banks have shown significant worsening since late 2007 with decreasing capital adequacy and liquidity ratios and increases in non-performing assets. The worsening of the banking sector’s condition is attributed to rapid growth in lending, financed through increased foreign borrowings in recent years, the conflict with Russia, and the impact of global economic slowdown. The situation was exacerbated following the August 2008 conflict with Russia, when the banking system witnessed a sizeable short-term deposit outflow. 33. There has also been a marked increase in deposit dollarization, as Georgian citizens’ confidence in the Lari was shaken by the November 2008 devaluation of the GEL. This has affected the banking system’s profitability resulting in negative returns on equity and assets (-12.6 percent and -2.6 percent respectively in December 2008). While the deposit base of 18 the banking system is now generally stable, the sector continues to be vulnerable to liquidity, exchange rate and credit risks. Figure 9 Commercial Bank Outstanding Loan Portfolio to Resident Legal Entities and Individuals (including LC and FC loans, principal and interest) Source: National Bank Bulletins on Monetary and Banking Statistics Figure 10 Overdue Loans and Accrued Interest as a Percentage of the Outstanding Loan Portfolio Note: Outstanding portfolio is as shown in Figure 9 Source: National Bank Bulletins on Monetary and Banking Statistics IFI support to the Banking Sector 34. The EBRD and IFC have recently provided the Bank of Georgia (which is the largest commercial bank accounting for 33 percent of the banking system’s total assets), with a financial package worth up to US$200 million to help it to manage the effects of the global financial crisis. The funds will support the bank’s capital base, provide longer-term liquidity and allow the bank to continue lending to retail clients, small and medium enterprises. EBRD, IFC and FMO (a Dutch bank) are supporting another major bank, TBC, by providing assistance of about US$160 million to support the restructuring of its operations. This assistance will help the bank to restart lending to the real economy, including small and medium sized enterprises. EBRD is also considering taking equity positions in two other banks, including Kartu Bank and People’s Bank. 19 Bank SME lending strategies 35. There is a lack of SME lending strategies in the commercial banks. Most commercial banks in Georgia – except perhaps ProCredit Bank and Kor Standard Bank, do not seem to have systematically laid out their corporate strategies for SME lending, especially to rural SMEs. ProCredit Bank is an exception and has laid out a well articulated strategy for its engagement with the SME sector. ProCredit Bank focuses on promoting a savings culture and lending to very small, small and medium-sized enterprises. Besides its head office, it has 58 branches and has lent about $300 million to 65,000 small clients. The Kor Standard Bank, which is a successor to the recently merged Kor Bank and Standard Bank owned by Dhabi Group, is planning to increase lending to agro-businesses. It aims to provide loans to farmers, small traders, fertilizer companies, seed and pesticide companies. 36. SME definitions based on loan sizes vary from bank to bank, which results in a lack of consistent data on lending to the SME sector. One of the largest banks treats loans below $150,000 as “micro� enterprise loans and loans between US$150,000 and US$3 million as SME loans; another bank treats loans up to US$50,000 as micro enterprise loans, those up to US$150,000 as small enterprise loans and those up to US$1.5 million as medium enterprise loans; and a third bank treats loans up to $20,000 as micro loans, those up to $150,000 as small loans, and those up to US$3 million as medium loans. SME Lending 37. Although there is an absence of clear data on SME lending, the National Bank of Georgia and major commercial banks, estimate that lending to SMEs is in the range of 20 percent to 30 percent of total commercial bank lending. The National Bank of Georgia does not publish any official data on commercial bank lending to SMEs, except for partial information on loans extended by non-resident agencies to local enterprises. There is no consistent and dependable data available on the commercial bank’s SME lending, either in individual banks or nationally, which would allow SMEs' access to finance to be systematically monitored. 38. Since mid 2008, the majority of commercial banks have temporarily suspended or reduced lending to SMEs and have begun to review, reduce and recall existing loans. These measures have been in response to SMEs’ growing default rate (20-25 percent). Any major restructuring of SME loan portfolios, however, has implications for commercial banks, which are already suffering liquidity problems from the financial crisis. 39. The provision of credit to SMEs in non-trading sectors in rural areas is very limited. Most commercial banks’ lending policies do not encourage financing rural clients or agro-based enterprises, which is considered to be highly risky. Georgian banks are predominantly urban based and are engaged in short-term lending. As of January 1st, 2009, the commercial banks’ outstanding loan portfolio to legal entities was predominantly for trade (47.1 percent) followed by industry (20.4 percent); construction (12.1 percent); real estate (4.2 percent); hotels and restaurants (2.3 percent); transport and communications (1.8 percent); and others (8.4 percent). Although lending to agriculture forestry and fisheries has grown substantially it has remained a relatively low proportion of the commercial banks’ outstanding portfolio around 1-2% between 2005 and 2009, with the exception of 2008 when it rose to over 6% (Figure 11 and Figure 12). The bulk of SME lending is for trading activities, which dominates the SME sector and only about 8-10 percent of total SME lending goes to real sector activities. Furthermore, about 60 percent of bank lending is 20 reportedly for Tbilisi-based urban enterprises and the balance for enterprises in the regions. Figure 11 Composition of the Loan Portfolio of the Commercial Banks (local currency & foreign currency st loan principal & interest GEL Thousand) as of January 1 2006 and 2009 Source: National Bank of Georgia’s Statistical Bulletins on Monetary and Banking Statistics. Figure 12 Commercial Bank Loan Portfolio for Legal Entities in Agriculture, Forestry, Fisheries as a Percentage of Commercial Banks’ Total Loan Portfolios (local currency and foreign currency, principal and interest) Source: National Bank of Georgia’s Statistical Bulletins on Monetary and Banking Statistics 40. SME Sources of Finance. One of the findings of MED Department of Statistics publication, Small and Medium business in Georgia 2008, was that during the year preceding Q4 of 2007, as much as 70 percent of the surveyed enterprises had not obtained loans or credits from banks or other financial institutions and those that had were engaged mainly in trading. During Q4 of 2008, the proportion of SMEs using loans and credits from banks and other financial institutions decreased from 28 percent to 22 percent. 41. Most SMEs finance operations from equity and informal borrowings. SMEs’ investments and working capital still remain limited by their equity and borrowings from informal sources or trade credits. According to the survey, as many as 64 percent of SMEs were 21 operating with own equity only; 20 percent primarily with own equity; and 7 percent with borrowed funds. 42. During Q4 of 2008, the majority of SMEs, 66 percent, were making payments only in cash or mainly in cash, with only 11 percent of enterprises using banks to transfer funds, such enterprises being mainly in real estate, leasing, trade and consumer goods. In Q4 of 2008, only about 0.1 percent of SMEs surveyed operated with foreign investments (0.2 percent in Q4 of 2007), predominantly in trading and real estate activities. 43. SME reliance on foreign investment remains narrow and confined to the financing of trading and real estate operations. In Q4 2008, only about 0.1 percent of surveyed SMEs depended on foreign funds for financing their operations (reduced from 0.2 percent in Q4 of 2007); of these nearly 40 percent were operating in real estate, renting and other businesses and 22 percent in trade and allied activities. Interest Rates, Exchange Risk and Collateral Requirements 44. Real interest rates coupled with exchange risks on dollar-denominated loans are prohibitive for SMEs, except perhaps for urban-based trading enterprises dealing in imported consumer products. While interest rates on bank loans vary from 20 percent to 30 percent per annum, depending upon the size and maturity of loans, the exchange rate induced risks are considerable. As the bulk of commercial bank loans to SMEs (over 60 percent) are indexed to the U.S. dollar, they carry an exchange rate-induced risk of 12-15 percent of the loan amount, making bank credit expensive and only viable for highly profitable enterprises, especially those engaged in trading of imported consumer goods. SMEs using domestic raw materials, serving domestic markets and doing business in Lari are not generally attracted to such loans. 45. Commercial bank collateral requirements are very conservative. Loans are made on the basis of the value of collateral (usually real estate) and the borrowers’ ability to repay the loan based only on existing income sources, not taking into consideration projected income from the investments to be financed. While residential or commercial condos are readily accepted as collateral across the country, land is taken as collateral only in urban areas, which excludes a vast number of agro-businesses from accessing bank finance. The situation is further exacerbated by the decline in the value of real estate during the past year. One major bank in Georgia values real estate used for collateral at only 25 percent its market value, which would severely reduce many borrowers’ access to credit. 2. Leasing 46. Georgia’s leasing industry is quite undeveloped. There are two main leasing companies in Georgia, TBC Leasing (subsidiary of TBC Bank) and GLC (subsidiary of Bank of Georgia) with TBC Leasing accounting for about 60-70 percent of the market and GLC, 30-40 percent. There are two other relatively new leasing companies, AG Leasing and Parex Leasing, which have relatively small market shares. IFC has provided loans to TBC and GLC leasing. Until the recent economic slowdown, the leasing market in Georgia had been growing due to the relatively low competition in the market and high returns. Leasing companies are currently facing the same liquidity problems as other financial institutions. 47. Leasing activity remains concentrated in Tbilisi because the leasing companies are reluctant to operate in the regions. The leasing products include mainly financial lease and financial 22 lease-back, with ownership rights automatically transferring to the lessee at the end of the lease term. Residual value leases are also offered, mainly for passenger vehicles. The leasing companies have also developed long-term partnerships with machinery and equipment suppliers. The financing amounts range from $10,000 to $500,000 with a maturity of 12-60 months and down payment of 20-30 percent. The lessees come from a range of industries, including construction, communication, distribution, road construction, light industry, medicine, power engineering, trade, food processing, and service. 48. In terms of taxation, leasing companies are treated as product delivery companies not financial service providers. Under current legislation, VAT is spread over the life of the lease and collected with each installment of the lease payment but the leasing company is required to charge VAT (18 percent) on the interest portion of the installment as well. Leasing companies believe that there is a need for a new law on leasing, incorporating the principles found in leasing legislation in Europe and in the USA. Leasing in Georgia therefore remains relatively undeveloped but there is potential for growth. 3. Microfinance Institutions 49. Most of the 30 microfinance institutions (MFIs) are in early phases of development except the following four, which are operating mainly with funds provided by their parent organizations or donors abroad. These include FINCA, CREDO, Crystal, and Lazaka Capital, which are all registered as Microfinance organizations with the central bank (NBG). Another important MFI, Constanta, has recently incorporated itself as a commercial bank. The operations of the four foreign funded MFIs have more or less similar characteristics and like commercial banks, their loans are predominantly dollar-denominated with interest rates ranging from 30 percent to 35 percent with foreign exchange risk borne by borrowers. 50. By law, the maximum size of a MFI loan cannot exceed GEL 50,000. FINCA has its own maximum limit of US$20,000 on any loan. The average size of its loans is about US$1000. FINCA has an outstanding loan portfolio of US$17 million with some 20,000 borrowers. With its 33 branches and 350 staff members, FINCA serves all regions. Credo has a regional hub in Ukraine. It has lent US$24 million to 23,000 borrowers. Credo’s average loan size is also about US$1,000. MFO Crystal now serves about 6,000 clients with a loan portfolio of US$6.5 million through its 12 offices across Georgia. Lazika Capital came into existence out of a small credit project launched by Oxfam GB and is now a registered MFI with a focus on providing micro and small loans to marginalized entrepreneurs and low income rural inhabitants. Lazika operates mainly in Samegrelo region and plans to expand to other regions. 51. The four MFIs earn a sizeable spread of about 12 percent, based on an average interest rate of 34 percent, cost of funds at 10 percent, and operational costs at 12 percent. MFIs have overdue loans up to 5-6 percent of the total portfolio compared to the earlier low level of about 1 percent until August 2008 conflict. Most MFIs provide agency services for insurance companies and handle domestic and foreign remittances to enhance their profitability. 52. Georgia’s law prohibits MFIs from accepting deposits from organizations or private persons. Any transition to licensing of deposit taking MFIs in future would require a more rigorous regulatory framework and adequate National Bank resources for regulation to safeguard 23 the interests of depositors. Legislation to enable MFIs to take deposits has been passed by in some transition countries, Kosovo for example (see Text Box 2). Text Box 2 Microfinance Organizations and Deposit Taking The Micro Finance Law passed in Kosovo in May 2008, provides for two categories of Micro Finance Institutions: (i) NGO MFIs which can provide only credit (and not accept deposits); and (ii) licensed MFIs which can do both, deposit-taking and lending. The benefits of transformation to licensed MFI includes: access to commercial capital; ability to attract savers; improved customer focus; potential future private sector ownership; and improved governance and accountability. The licensed MFIs accept savings and time deposits and other financial services such as letters of credit, bonds and guarantees and other services permitted by the Central Bank. To qualify for a license to accept deposits the licensed MFIs must: a) have operated as a NGO MFI for three years; b) must ensure that total liabilities do not exceed five times the amount of equity and; c) must maintain a liquidity reserve equal to 10% of deposit liabilities. There are other prudential regulations, such as central bank oversight and independent audit. 4. Credit Unions 53. International experience shows that credit unions can build a strong membership base in the communities they serve and provide financial intermediation for its members, interacting with the rest of the financial system. Credit unions (CUs) in Georgia are mainly established by the rural population, using cooperative principles to serve their respective communities. In Georgia, the number of credit unions has contracted sharply since their establishment in mid-1990s. Under the first World Bank-IFAD funded Agricultural Development Project (1997-2005), some 164 CUs were created in the first two years of the project. This rapid expansion was premature and characterized by widespread fraudulence and mismanagement. There was little emphasis on savings mobilization or sustainability. It is reported that some of the CUs emerged primarily from local money lending operations to take advantage of the legal protection offered by the cooperative law. Through the processes of central bank supervision, the number of CUs now stands at 18 with a turnover around $1-$2 million equivalent. The central bank is concerned about the performance of credit unions, which has been poor to date, but the vision of establishing a credit union system to provide intermediation for the community should not be lost and a new legal, operational and regulatory framework may have to be developed to promote and deepen sustainable credit union activity in the country, particularly for rural communities. Table 14 shows the balance sheets of the credit unions between 2005 and 2008. 24 Table 14 Assets and Liabilities of Non-Bank Depository Institutions (Credit Unions) (GEL 000) End of Q 4 2005 2006 2007 2008 Assets Cash 129 233 218 197 (12%) Net Loans 1,549 1,559 927 1,301 (79%) Other Assets 113 171 196 149 (9%) Total Assets 1,791 1,963 1,341 1,647 (100%) Liabilities Demand Deposits 84 102 136 129 (8%) Term Deposits 850 975 672 879 (53%) Loans from Financial Organizations 544 448 134 153 (9%) Other liabilities 79 171 164 249 (15%) Equity 234 267 235 237 (14%) Total Liabilities 1,791 1,963 1,341 1,647 (100%) 54. Section III has so far described macro-economic and financial sector constraints, which affect all types of rural businesses. The study now examines some policies and constraints, which particularly affect the agricultural sector. D. Agricultural Trade Policy 55. Georgia has aggressively liberalized its trade policy through abolition of import/ export quotas, conversion of non-tariff barriers to tariffs, reduction of tariff rates, simplification of tariff rates from sixteen to three rates (0 percent, 5 percent and 12 percent) and the on- going pursuit of free trade agreements (FTAs). The trade agreements to which Georgia is party include: i) WTO under which Georgia enjoys Most Favored Nation (MFN) treatment with 150 member countries and is a beneficiary of Generalized System of Preferences (GSP) of the EU, US, Canada, Switzerland, Japan, and Turkey; ii) FTA with Turkey (2008); iii) FTA with CIS Countries; iv) GSP with EU (1999 renewed 2005); v) GSPs with US, Canada, Switzerland and Japan. Georgia is currently in discussions with the EU on initiation of negotiations for an EU FTA in 2009 and is considering pursuit of a US FTA. 56. In adopting this relatively liberal trade policy, the government has had to balance achievement of several often conflicting objectives which include, ensuring cheap imported food for the population, protecting rural household incomes, exposing the sector to competition to increase competitiveness and avoiding inter-sectoral distortions in the economy. This has resulted in a lightly protected agricultural trade regime in which agricultural products enjoy a higher level of protection than other products. Nevertheless, farmers are having difficulty in competing with Georgia’s main trading partners. 57. Georgian farmers face tough competition from its main trading partners, whose agricultural sectors enjoy higher levels of trade and protection than Georgia both in terms of MFN applied tariffs, the percentage of items which are duty free and non-trade protection through various subsidies (notably the EU and Kazakhstan)(Table 15). Georgia’s top four agricultural export markets in 2007 were Ukraine, Armenia, EU and Kazakhstan and its top five import suppliers were Russia, Ukraine, Turkey, Kazakhstan, and the EU. Georgia has a lower average MFN applied tariff than the EU on all top ten product groups including animal products (-16.3 percent ), dairy products (-56.9 percent), cereals -11.7 percent) and sugar products(-19 percent) (Table 16). Turkey has a simple average applied MFN tariff of 46.7 percent compared to Georgia’s 8.8 percent in Georgia. While Georgia benefits from 25 preferential tariffs under its FTA with Turkey, this does not include a number of key agricultural products groups, such as various categories of nuts, grapes, citrus and dried fruit and the tariff quota volumes on many key products, to which preferential tariffs do apply, are low, such as apples (2,000 MT), tomatoes (500 MT) and some preserved vegetables (2,200 MT) 16. 58. The considerable appreciation of the exchange rate discussed in section III has clearly added to difficulties of Georgian agriculture in competing with their trading partners. The declining agricultural trade balance demonstrates that these constraints represent a very major obstacle to growth of the agricultural sector, in both domestic and export markets. Table 15 Comparison of Tariffs on Agricultural Products with Selected Trading Partners Source: World Tariff Profiles 2008, WTO Table 16 Comparison of Tariffs in Georgia and the EU by Product Source: World Tariff Profiles 2008, WTO Table 17 Exports to Major Trading Partners and Duties Faced Source: World Tariff Profiles 2008, WTO 16 Ministry of Economic Development Web Site. Georgia National Investment Agency January 2009 26 E. Land Reform Land Privatisation Process 59. The 1992 land privatization program, which was generally completed in 1998, transferred 942 thousand ha to private individuals and households free of charge 17, including nearly 26 percent of all agricultural lands (761 th. ha). This included: i) homestead, garden, vegetable- growing and summer cottage plots; ii) nearly 60 percent of the arable land and perennials; iii) some meadows and pastures and; iv) non-agricultural lands (181 th. ha). In the lowlands, land was distributed into three categories: a) citizens directly involved in farming were entitled to 1.25 ha per household; b) rural residents who were not involved in farming were entitled to 0.75 ha; and c) urban residents were entitled to 0.25 ha. In the highlands, eligible households in categories a) and b) were allocated up to 5 ha, and in category c) they were allocated up to 1 ha. The land reform granted 1 million families, or an estimated 4 million Georgians, 0.94 ha of land per household on average, split in nearly 3.8 million small parcels with an average size of 0.25 ha. The process resulted in each household being allocated 2 to 5 land parcels, located in different areas and forming fragmented farm units. 60. The remaining agricultural lands in state ownership (approximately, 2,153 th. ha) were targeted for leasing out to private farmers or legal entities, where actual demand existed (mostly, cultivated lands), while for the balance of pastures, there was community access for common use. The term of the lease contracts was generally more than 10 years (up to 49 years, with revision every 10 years). The lease price was fixed at the amount of the annual land tax. The size of lease plots varied from blocks of several hundred hectares to 0.5 ha. The approximate balance of agricultural land by type of tenure in 2002 is shown in Table 18 18. Table 18 Structure of Land Ownership at the End of 2002 (Thousand ha) Total Private lands State lands Total Leased out Vacant Homesteads 20 (100%) 20 (0%) 0 Arable lands 771 (57%) 436 (43%) 335 (69%) 231 (31%) 104 Meadows 138 (31%) 43 (69%) 95 (48%) 46 (52%) 49 Perennials 255 (69%) 176 (31%) 79 (34%) 27 (66%) 52 Pastures 1,730 (5%) 87 (95%) 1,644 (36%) 598 (64%) 1,046 Total 2,914 (26%) 761 (74%) 2,153 (42%) 902 (58%) 1,251 Source: World Bank estimation based on reconciliation of various sources, e.g. ‘Land Balance, April2002, State Department of Land Management. 61. The rights identification documents issued during the first phase of land privatization were: i) hand-over and acceptance acts issued to households or individuals; ii) ownership certificates signed by the President; iii) abstracts from the household registers and; iv) “gardeners’ certificates�. In some locations, these rights identification documents contain numerous technical errors since there were no surveys at the initial stage of distribution and the land allocation plots were designed only conceptually on inaccurate and outdated cadastral maps from the kolkhoz period. The adverse consequences of this are discussed under Land Registration below. 17 “social privatization� 18 Approximation, reconciling various sources, e.g. ‘Land Balance, April 2002, State Department of Land Management. 27 62. The second phase of land privatization started in 2005 and is almost complete but is still ongoing. This is because lessees have the option to wait until the completion of their current lease term before privatization of the land being leased is launched. The Georgian Government is divesting itself of all state owned rural lands, in which there could be some private interest. The pastures, alpine (approx. 900 th. ha) and village ones (approx. 580 th. ha), are being transferred to local self-governments (sakrebulo). Pastures located at the cattle-breeding farms are to be sold and the rest will be leased. Another 464 th. ha of agricultural lands are earmarked for and undergoing privatization of which 299 th. ha are under state lease and 165 thousand ha are vacant lands. Prices for state land privatization (both sale and lease) are stipulated by law. The valuation formula is based on land use and the relevant land tax and generally results in a price lower than the market price 19. Land sale can take place in three ways in the following order of priority: i) direct sale to the lessees for a price fixed at 10 times the amount of the annual land tax; ii) special auctions – if the lessee does not wish to buy the land – where only local rural residents can bid, with an opening price equal to twice the annual land tax; and iii) open auctions, as a last option, if the first two options fail. From the onset of the second phase of reform in 2005 to the end of 2008, 162.5 thousand ha of land were privatized 20: i) 137.7 th. ha in 8,757 parcels by direct sale; ii) 8.6 th. ha in 1,205 parcels by special auctions; and 16.1 th. ha in 2,988 parcels by open auctions. 63. In 2007, the President launched a new “Agro 100� program 21, for privatizing pre-identified land plots over 50 ha by sale to local and foreign investors in agriculture, through a competitive, transparent tender procedure, with the opening price equal to 20 percent of the market value. Best price, rural employment, production and export potential are the main evaluation criteria for the offers. The initial target of 50 thousand ha of agricultural land is to be exceeded; by the end of 2008, a total of 631 plots 22 covering 117.4 th. ha were identified of which 5.7 th. ha were sold. Thus, by the end of 2008, an additional 168 th. ha of land will have been privatized, increasing the estimated share of private agricultural lands to 929 th. ha (32 percent of all agricultural land or 78% of all agricultural land excluding pastures). 64. Regardless of the substantial privatization to date, a sizeable share of the lands will remain state property once the privatization is over – lands in the state border security strip and the border line itself 23, all forestry lands, sizeable pastures, cattle walkways, lands of water funds, recreational land, lands under historical, cultural, nature and religious monuments, nature reserves and protected territories, as well as lands under infrastructure. As a next step towards private management of state lands, forestry lands are being leased out to the private sector under a licensing regime by the central government. Further, the local authorities (sakrebulo) are charged with the identification of vacant land (considered state- owned) and its privatization, as well as the leasing out of pastures. 19 There are also numerous benefits if the purchaser meets certain criteria for the payment (pay early, pay cash, etc.). 20 Average parcel sizes: i) direct sale – 15.7 ha; ii) special auction – 7.1 ha; iii) open auction – 5.4 ha. 21 For the 100 Agricultural Enterprises. 22 Average area 186 ha 23 The strip is 5 km wide, or 750 th. ha includes agricultural lands; the border line is 500 m wide, or 75 th. ha. 28 Land registration 65. The present land registration system in Georgia is a result of the reforms after 2004, triggered by the Law on State Registry, which established the new National Agency of Public Registry (NAPR) as a self-financing legal entity under to the Ministry of Justice. All cadastral surveys required for land registration are carried out by the private sector. NAPR is very efficient by international standards. Georgia’s property registration ranks second in the Doing Business 2009 survey. Registration of a secondary transaction can be completed on the day of application and registration fees are affordable (50 GEL/parcel) but land survey fees are higher (approx. 500 GEL/parcel of 1 ha 24) and are a disincentive for voluntary first registration of rural lands. NAPR information and communication technology is well developed. NAPR is centralizing the data in the Tbilisi headquarters and in the course of the next year, registration will be centralized in 8 regional offices. 66. The initial privatization of land in the 1990s was done rapidly with the recognition that there may be inaccuracies in the process but that it was more important to complete the process quickly. A specific feature of Georgian land privatization has been that land reform results were only partially registered in NAPR 25. Although no strict statistics are available, the percentage of registered immovable rural properties (first registration) is around 30 percent. A conservative estimate indicates that there are at least 1.2 million to 1.4 million rural parcels that are not registered. Most of the systematic cadastral mapping efforts supported by donors 26 took place before the set up of NAPR, and the results of these mapping campaigns under some donor projects were not combined with systematic field adjudication and land registration in the property register. Thus, the cadastral maps and ortho-photos produced may in some cases be insufficiently correct or outdated, although this may be a specific to certain donor projects. Experts at NAPR see the completion of first registration as an essential foundation for the future development of the land market. First registration of the property is a pre-requisite for registering secondary market transactions (sale, lease, mortgage) because it provides the ultimate clear title necessary for secondary market transactions. A mandatory requirement in case of first registration is the production of a cadastral survey plan of the plot / property which is then reflected in the cadastral index map. 67. Due to the initial stage of land distribution (1992-1996), in which parcels were allocated without field adjudication or cadastral surveys of the boundaries, there is a high incidence of technical errors in rights identification documents. Some of these errors can be fixed in NAPR, but in case of first registration, approximately 20 percent (one in every five) of these title documents end up in the administrative courts for rectification. The most frequent problems are technical errors, including discrepancies in plot area and in the location of boundaries, errors in the owner identification data and overlapping claims. The high rate of first registration cases reaching courts is a potential bottleneck for the land markets in the future. 24 Survey fees depend on the size of property (from 0.03 GEL/m2 to 0.10 GEL/m2, resulting in a 1 ha plot fee ranging between 300 GEL and 1000 GEL) and the transport costs to the location. Buildings survey cost is 1 GEL/m2. 25 Privatization documents and the land itself was handed over to the new owners, but neither a cadastral survey nor a legal map of the plot were made and no legal record for this privatization transaction was filed with NAPR registers. 26 The World Bank, KfW – in 4 big cities and 48 raions, USAID 29 Land taxation 68. Agricultural land tax (“property tax on land�) is an annual local tax, the revenues from which are transferred to the local self-government (sakrebulo) budgets. Tax rates are defined by local self-government bodies within the limits (base rates) set forth by the Tax Code and according to the quality and location of the land. A base rate can be reduced up to 50 percent or increased up to 150 percent depending on the soil category and location. Taxable persons are the owners, state-land users, and possessors, including both natural persons and legal entities. Lessees of state land are also liable to pay land tax, together with the lease (rent). The Tax Code establishes maximum and minimum base rates by administrative-territorial units for arable land and perennials, as well as for pastures and meadows. Arable lands and perennials are categorized as either good or poor lands. Pastures and meadows are categorized as either natural or cultivated as shown in Table 19. 69. Tax exemptions have been granted to some persons or agricultural lands, including: parcels of natural persons not exceeding 5 ha; parcels with soils damaged by natural disasters; taxpayers who received agricultural lands for reclamation and individuals and households who were resettled (for the first 5 years); plots hit by natural disasters (blizzard, hail, drought, flood) and other force majeure and; taxpayers who are residents of certain disadvantaged mountainous territories. Table 19 Land Taxes Base Tax Rates Arable lands & Perennials Pastures & Meadows (GEL/ha) good poor natural cultivated max 57 31 6 8 min 13 8 2.5 4 Land Market Activity Text Box 3 Land Privatization 70. Rural land markets in Georgia are still weak but the From May 2005 to December 2008, there were nearly privatization of further state 13,000 privatisation deals for 168,187 ha (12.9 ha/deal, 295 land will contribute to a more deals/month), as follows: active land market in future. • 8,757 leaseholds for 137,791 ha were privatised by Rural land sales between direct sale to the leaseholder (15.7 ha/deal, private owners are 199 deals/month); approximately 18 percent of all • 2,988 privatisation deals by special auctions for land sales, with an average 16,125 ha (5.4 ha/deal, 68 deals/month); activity of 785 sales per month. • 1,205 privatisation deals by open autions for 8,578 ha (7.1 ha/deal, 27 deals/month). State land sales add a further 324 rural land deals per month From mid-2007 to the end of 2008, another 5,693 ha were (including first registration of sold by circa 30 tendering procedures under the Agro 100 privatized lands), leading to initiative. 1,100 farm land sales per month in 2008. Non-market, gifts and inheritance land transfers amount to a further 436 transfers per month. However, overall, a very small percentage of the agricultural land plots (≈1 percent) change hands in a year. Rural land leases / rents between private parties are not popular (less than 2 percent of the land is rented from private owners). The 2008 statistics indicate that there are around 94 rent agreements per month and less than 1 lease monthly, although the statistics may not reflect the real activity in the lease market 30 because these agreements are often verbal and not registered to avoid registration costs. Agricultural land mortgages are not an important form of collateral with farm land being used as collateral in about 7 percent of all newly registered mortgages or 258 mortgages per month. Liquidation of small areas of collateralized agricultural land is expensive and difficult and so property in Tbilisi is a far more attractive form of collateral for banks. Rural land values are low with the exception of those lands which are close to bigger cities or resort centres. The lowest market prices for arable lands are around 1,000 GEL/ha and in the case of perennials prices can reach 10,000 GEL/ha. This is a result of the presently low demand for farm lands which could not be converted to non-agricultural use. No institution for market valuation of lands currently exists. Institutional arrangements for management of public land 71. Until 2004, the State Department for Land Management (SDLM) 27 conducted all major land administration functions: land registration and cadastre; land valuation; land reform, land arrangement and disputes over property; control and protection of land use and natural resources; and land statistics. After the dissolution of SDLM in 2004, management functions for lands in public ownership are fragmented between several ministries and local self- government bodies. The allocation of lands in public ownership between the central government / line ministries, and the local governments (municipalities, sakrebulo) is still incomplete, leading to poor land governance. Local governments are charged with the task to investigate and identify all state lands but there is no comprehensive inventory, “balance-sheet of lands�, or cadastral record of lands in public ownership to facilitate their work. The administrative and political boundaries between local authorities’ jurisdictions are not yet settled, leading to uncertainty and disputes between sakrebulo about lands close to the boundaries. In general, the institutional arrangements and capacity of sakrebulo to deal with some land management issues seems insufficient. For example, the rules for access to, and use of, common lands like grazing lands and village pastures are unclear and not stipulated in any legislation. This potentially creates a source of conflict over the access to resources. Reportedly, there is already overgrazing taking place in some village / lower altitude pastures. 27 State Department of Land Management 31 Figure 13 Responsibility for Land Management and Administration Forestry Land 72. In 2009, the government put in place new plans to increase private sector management of some forest land through leasing. The standard licensing terms and conditions give very short term tenure security to the licensee (5 years). These leases are potentially problematic because the delimitation of forests is poor and because they are drafted without a prior inventory of the forest resources to be leased out by government. Instead, the lessee is required to conduct an inventory and to draft a management plan but it is difficult to see how the authorities will be able to assess the accuracy of the basic data used and accordingly the technical and environmental feasibility of these plans. According to the data of the Ministry of Economic Development, 64 lots have been prepared for forest licensing, amounting to 162,173 ha, of which 141,515 ha are covered with forests with an average lot area of 2,534 ha. 73. In conclusion, while there are a number of technical issues to address in preparing for a more active land market, privatization is well advanced and the land market is not seriously impeding structural change or constraining agricultural sector growth. 74. The study now examines the policies and constraints relating to the public infrastructure and services, which are important for the farms which have emerged from land privatization. F. Public Expenditure on Agriculture and the Environment 28 75. This section examines trends in budgeted spending on agriculture and the environment between 2007 and 2009. Summaries of the budgets, categorized by organization and functional categories, are provided in Figure 15, Figure 16 and Figure 17. 28 Notes to budget data: a) Source for all original budget data is Ministry of Finance. Categorization of budgets was done by the World Bank Team. b) 2007 data is actual expenditure, 2008/ 09 data is budgeted expenditure. 32 Overall Sector Budgets Allocations 76. Overall budgeted spending on agriculture and the environment steadily increased as a percentage of GDP until 2007 and then declined sharply in 2008, before recovering slightly in 2009 (Figure 14). Total budgeted spending on the agriculture and the environment was 0.66 percent of GDP (GEL 132.7 million) in 2009. Total spending on agriculture was 3.63 percent of agricultural GDP 29 (or GEL 88.0 million) in 2009. Figure 14 Agricultural Budgets as a Percentage of GDP Source: Ministry of Finance Budget Allocations by Organization 77. The MOA budget has decreased substantially from GEL 87.7 million in 2007 to GEL 44.2 million in 2009, while the budget of the Ministry of Environmental Protection and Natural Resources (MENR) increased from GEL 37.5 million in 2007 to GEL 44.7 million in 2009 and that of the National Service increased from GEL 7.1 million to GEL 10.2 million (Table 20 and Figure 15). There has also been a marked increase in co-financing of donor funded projects from GEL 6.5 million to GEL 27.5 million 30. The decline in the share of the MOA in the total budget is largely as a result of the cessation of food aid after 2007 and cessation of input provision after 2008. Table 20 Budget by Organization (GEL 000) State Organization 2007 2008 2009 MOA 87,665 51,089 44,161 National Service 7,066 5,803 10,221 Samestri (Dept. of Viticulture) 7,891 12,369 4,250 Laboratory of MOA 1,994 1,637 2,000 Donor Project Co-financing 6,484 9,412 27,412 MENP 37,527 32,256 44,642 Total 148,627 112,566 132,685 Source: Ministry of Finance MOA Budget by Functional Category 78. For the purposes of analysis in this report, the MOA budget items have been categorized under 10 functional categories. 29 This assumes the agricultural sectors share in GDP in 2009 will remain the same as in 2008 at 12%. 30 This includes increased contributions to Avian Flu, Upland Development and Rural Development Projects. This figure excludes donor projects under MENP which are included as part of the MENP budget and which declined from GEL 11.0 in 2007 to 5.1 million in 2009. 33 • MOA Operations • Machinery Programs • Drainage and Irrigation Rehabilitation • Drainage and Irrigation Operations • Extension Services • Exhibitions • Sub Sector Programs • Provision of Food • Provision of Inputs • Other 79. There has been a substantial shift in the composition of the MOA budget between 2007 and 2009 (Figure 16). Specifically, there has been a marked shift in expenditure between 2007 and 2009, from income support in the form of food aid which represented 60 percent of the MOA budget in 2007, to direct support in the form of fertilizer which represented 65 percent of the MOA budget in 2008, to increased expenditure on rehabilitation of the irrigation and drainage systems and machinery provision which represented 34 percent and 51 percent respectively of the MOA budget in 2009. Sub-sector specific support programs such as citrus, apple and livestock support programs which were a minor part of the MOA budget ceased in 2007, except for support to the wine industry under the Samestri budget which continues, albeit with a lower budget in 2009 and less direct support for growers. National Service Budget by Functional Category 80. The National Service budget increased from GEL 7.1 million in 2007 to GEL 10.2 million in 2009 (Figure 15). While spending on plant protection measures increased six fold during this period, spending on epizootic animal disease control declined by more than 50 percent (Figure 16). MENP Budget by Functional Category 81. The MENP budget increased from GEL 37.5 million GEL in 2007 to GEL 44.6 million in 2009 (Figure 15). The main change in the composition of the MENP budget has arisen from the establishment of the National Environmental Agency, which was allocated 30 percent of the MENP budget in 2009 (Figure 16) MENP obligations for co-financing donor projects have declined substantially. Otherwise, the composition of the MENP budget has remained relatively stable. Agricultural and Environmental Budgets by Public and Private Functions 82. For the purpose of analysis the budgets for MOA, MENP, National Service, MOA Laboratory and Samestri were grouped into the following seven categories: • Operations • Typically Public Service Investment • Typically Public Service Recurrent Costs • Typically Private Sector Investments • Typically Private Sector Recurrent Costs • Direct Input Provision • Direct Food Provision 83. Typically, public sector functions are considered to be irrigation and drainage rehabilitation and maintenance, extension services and all MENP environmental protection functions. 34 Typically private sector functions are considered to be food provision, input provision, machinery provision, and sub-sector specific capital investments such as investment in vineyards. The categorization into typically public and private functions is somewhat subjective. In transition countries, while rehabilitation of the on-farm irrigation and drainage systems under ownership of water user organizations could equally well be considered as a private responsibility, the initial rehabilitation of these systems has typically been funded by government. This is because of the poor state of the systems at the time when they were transferred to water users and the inability of water users to access finance for rehabilitation. Similarly, while extension services could also be considered to be a private sector function, these are typically provided by the public sector, particularly extension services which relate to public goods such as environmental protection, public health or which target the poorest rural citizens. 84. The categorization demonstrates a positive trend away from public spending on private sector functions, which declined from 59 percent in 2007 to 18 percent in 2009, towards more spending on public sector functions which increased from 20 percent to 44 percent (Figure 17). Nevertheless, further progress is needed in this respect. In 2009, 17 percent of the agricultural and environmental budget, including over 50 percent of the MOA budget, is for what are essentially private sector type investments (specifically the machinery program). [It is understood that funding for the machinery program may cease in 2009, although it remains a prominent feature in the MOA agricultural strategy 2009-2011]. In contrast, to the considerable spending on these private functions, there is a void in spending on essential public services to protect public health, (such as disease control programs), to protect the environment (such as laboratory testing) and to stimulate the private sector (such as seeds testing and extension services). All of these essential public services would represent a relatively small percentage of total current spending. 85. The following section now examines selected agricultural services and infrastructure under public and / or private provision in more detail. 35 31 Figure 15 Agricultural and Environmental Budgets by Organization 2007-2009 31 Source for all budget data in Figure 15, Figure 16 and Figure 17 is Ministry of Finance. The data was categorized by the World Bank Team. 36 Figure 16 Agricultural and Environmental Budgets by Functional Category 2007-2009 37 Figure 17 Agricultural and Environmental Budgets for Public and Private Functions 38 G. Agricultural Services 86. Consistent with its general policy of establishing small efficient government, minimizing opportunities for corruption, reducing trade barriers and containing public expenditure, the government has pursued a policy of aggressive deregulation and privatisation of agricultural services. The private sector has responded to some extent, particularly in the supply of inputs with the support of donor funded projects, but essential services, including machinery contracting, sanitary and phytosanitary services, veterinary services, extension, irrigation, drainage and advisory services, are severely lacking, which is a key constraint to raising competitiveness of the agricultural sector. 1. Machinery The World Bank ECA Mechanization Study 87. The World Bank undertook a study of mechanization in 24 countries in the ECA region during the period 1990-2005. Countries were classified according to: a) their reform status in 2005 and; b) labor intensity of the agricultural sectors in 1989-1991, based on the argument that these factors would be key determinants of mechanization. Reform status in 2005 was based on World Bank reform indices which examine progress in the marketing environment, land reform and rural financial sector reform - countries were classified as either EU accession countries such as Poland, transition countries such as Georgia or truncated reform countries such as Uzbekistan 32. Georgia was classified as a labor intensive transition country. 88. The paper argues that once a first threshold of reforms in market liberalization, farm privatization and land reform have been achieved, there will be incentives to invest in machinery. Even in labor intensive agricultural systems, mechanization, particularly of power intensive operations, is expected to bring about productivity gains. This first threshold of reforms, have taken place in accession and transition countries but not in truncated reform countries. Changes in the relative prices of farm labor and capital, should bring about changes in the relative use of farm labor and machinery but the response will be constrained until a second threshold of reforms has been achieved. These include wider economic reforms such as trade, competition and exchange rate policy and deeper financial sector reforms, which improve farmers’ access to rural credit and the availability of appropriately powered machinery. The paper argues that by 2005, the second threshold of reforms had taken place in accession countries but not in transition countries and consequently, inadequate machinery remains a major constraint to agricultural development. Mechanization Trends in Georgia 89. Georgia largely conforms to this hypothesis and the trend in mechanization between 1995 and 2005 was similar to that in other transition countries. In transition 32 Accession countries included Bulgaria, Croatia, Poland, Romania, Slovenia, Turkey, Czech Republic, Estonia, Hungary, Latvia, Lithuania and Slovakia. Transition countries included Albania, Armenia, Georgia, Kyrgyzstan, and Kazakhstan. Truncated reform countries included, Azerbaijan, Moldova, Tajikistan, Uzbekistan, Belarus, Russian Federation, Ukraine. 39 countries, while interest rates declined and real farm wages increased, tractor use remained stable, and combine use declined. Stagnant mechanization during this period is also reflected in capital to labor ratios. During this period, while tractor use remained stable, imports were low and old machinery was not replaced, leading to a decline in the overall condition of machinery. Farmers compensated for the lack of mechanization to a limited extent by investing in horses. This trend contrasts sharply with accession countries where there was a major increase in tractor use during this period. However, the degree of mechanization in Georgia was better than in truncated countries where there was marked decline in tractor. 90. Since 2005, many of the second threshold of reforms referred to in the study have taken place in Georgia, including greater trade liberalization, deeper financial sector reforms and deregulation and Georgia now ranks as 15 out of 181 countries in the IFC Doing Business Survey but mechanization (other than that implemented under government funded programs discussed below) remains stagnant 33 and there are clearly other sector specific demand or supply side constraints holding inhibiting mechanization. On the demand side - although agricultural sector growth is low, and the sector is adjusting to a liberal trade regime, the loss of Russian markets and limited public services, the strong demand for government and MCC machinery, suggests that there is substantial demand for machinery. The lack of private sector credit and lease finance is certainly a major constraint for famers and contractors as for other small rural businesses, as discussed under section IIIC. On the supply side - tariff and administrative barriers to trade have been reduced, businesses are not heavily regulated and Georgia is rated highly in terms of its doing business environment, so there are few barriers to the importation of machinery or establishment of dealerships. However, international machinery suppliers in Georgia argue that while the government is distributing machinery under preferential terms (discussed below) and while there is limited private sector finance available to the sector, the foundation for their expansion is weak. It appears therefore, that although Georgia has implemented many of the second threshold of reforms which should facilitate mechanization, limited private sector finance for machinery, partly as a result of crowding out by government, is a key constrain to further mechanization. Government Machinery Programs 91. The current government responded to stagnant mechanization by investing heavily in government funded machinery programs some of which have been co-financed by JICA. Total expenditure on machinery programs is budgeted for GEL 22.4 million in 2009. Machinery has been procured by government through international tender and distributed throughout the country to farmers groups or cooperatives. Machinery is provided under a 7 year repayment agreement. Suppliers are required to provide a one-year warranty on machinery and more recently, suppliers are required to demonstrate that they will establish some form of service facility in each of the regions. As a result of the annual tenders, a number of major international suppliers now have dealerships in Tbilisi, including Ford/ New Holland and Claas. Other local dealers provide cheaper machinery from Europe, Turkey, Belarus and 33 Discussions with the main machinery dealerships indicated that the majority of their agricultural sector business is generated by the government machinery programs. 40 elsewhere. In addition to government programs, the Millenium Challenge Corporation (MCC) has provided tractors and implements to private operators and have grant financed 70 percent of costs with the remaining 30 percent covered by beneficiaries. MCC has also established 22 general purpose agricultural service centres and 12 of these provide machinery services. 92. The World Bank study on mechanization in ECA, examined government machinery programs in Russia, Ukraine, Belarus, Romania, Czech Republic, and Turkey. These programs have included state procurement, subsidized credit schemes, grant schemes (and protection for domestic machinery producers although this is not relevant to Georgia which does not have any domestic production capacity). The study concludes that these programs contributed to increased investment in machinery but had generally failed to arrest de-mechanization. 93. Similar conclusions can be drawn for the Georgia’s publicly funded machinery programs over recent years. While these programs have encouraged international suppliers such as Claas and Ford/ New Holland to establish dealerships in Tbilisi, and provided urgently needed machinery to the sector, they do not provide a long term foundation for the development of the machinery market in Georgia and may be undermine its long term development by crowing out the private sector. This view is supported by discussions with the current machinery suppliers, who although benefiting in the short term from government programs, do not see these programs as a healthy long term foundation for their expansion. 94. There are a number of drawbacks to the current machinery programs. Despite making the establishment of service facilities a requirement for bidding, it is unlikely that these services will continue to be provided once the international tenders cease and many of the tractors provided have and will continue to fall into a state of disrepair. Only 100 of the 185 units purchased from one supplier in 2002/2003 are reported to be still in working order. While attempts have been made to ensure that machinery is in line with farmers’ needs, central government procurement inevitably means that there is a somewhat limited choice of types and power of machinery. 95. It is understood that funding for the machinery programs may be excluded from the 2010 budget although it still features prominently in the MOA strategy 2009-2011. The challenge for government is now to stimulate the provision of private sector finance for machinery and facilitate the development of existing and new dealerships and a network of service facilities. 2. Irrigation and Drainage Infrastructure Rehabilitation to Date 96. The irrigation and drainage system inherited from the soviet system has been poorly maintained over the last 15 years and fallen into disrepair. In eastern and southern parts of the country, annual rainfall averages 400mm and rainfall is unpredictable, so agriculture relies fully or partially on irrigation, depending on the location and year. In 2001, only about 110,000 ha were supplied with irrigation water and only 20,000 ha were drained. In 2006, the government aimed to restore the total irrigation area up from 116,000 ha to 300,000 ha, mainly in Eastern Georgia and the drainage system from 34,000 ha to 110,000ha, mainly in Western Georgia. 41 97. Between 1997 and 2006, the EU Food Security Program made important contributions to rehabilitation of the system. The World Bank, under the Irrigation and Drainage Community Development Project (IDCDP) (completed 2009), has rehabilitated off-farm drainage structures serving 16,600ha, off-farm drainage systems serving 4,200 ha, rehabilitated on-farm irrigation and drainage structures serving 29,300ha and repaired damage from the 2005 floods. However, much remains to be done and considerable further investment will be required to meet the government’s 2006 target 34. The government has prioritized drainage and irrigation which represents 37 percent (GEL 16.5 million) of the total MOF budget in 2009, higher than expenditure in the years 2005-2008 during which the annual budget was typically around GEL 10 million per annum 35. Institutional and Legal Reforms to Date 98. In the 2006, the government abolished the Department for Amelioration Scheme Management (DASM), which was responsible for management of the off-farm system and established four state-owned limited liability companies (LTDs) to which responsibility for operation of the primary and secondary (off-farm) systems were transferred. 99. Amelioration Service Cooperatives (ASC) were formed in 2001 to manage on-farm systems but were often poorly governed and characterized by poor financial accountability, rent seeking and poor representation of the water users who they were supposed to represent. In 2001, on the advice of the Bank, the government transformed ASCs into Ameliorative Associations (AAs), and amended the Law on Amelioration accordingly. In general, each AA was to manage the on-farm irrigation and drainage system of a single hydraulic unit. The establishment of AAs required a minimum participation of 51 percent of water users and the charters of the AA’s were designed to create a high level of participation of its members in water management. The law allowed AAs to charge its members for the wholesale cost of water from government plus management operation and maintenance costs. 259 AAs were established covering 237,000 ha, of which 43 were targeted for support under the IDCDP. A regulatory office (RO) was informally established in the MOA in 2004 to audit and ensure quality of service by AAs but the RO was essentially abandoned in 2006, along with the DASM. 100. In 2005, the government effectively withdrew support for the development of AA and consequently the majority of AA are non-functional or very weak. The LTDs were intended to be financially independent. This required raising water user charges to AAs 12 times to GEL 75 per ha at a time when the system was in poor repair and the LTDs could not guarantee water supply 36. Farmers have been reluctant to pay for water under such circumstances and relationships between LTDs and AA have deteriorated to a point where in 2008, collection of charges from farmers by the AAs averaged 16 percent of amounts due (Table 21). AAs managed to secure agreement 34 The main source of data for this section is the WB IDCD aide memoires of 2008 and April 2009 unless otherwise stated. 35 Source: Ministry of Finance Data. 36 Charging a flat rate per ha regardless of the crop makes little sense when different crops require different amounts of water but this was probably only a small cause of farmers unwillingness to pay given that water delivery for all crops was poor. 42 from their members for increased membership fees to cover their other management operation and maintenance costs between 2005 and 2008 but collection rates have consistently declined to very low levels. Table 21 AA Membership Fees Source: IDCDP Aide Memoire 101. These institutional arrangements for management of the on-farm system are therefore now extremely fragile and do not provide a sound foundation for future management of the system or for further investment in rehabilitation. Furthermore, the AAs are supposed to be re-registered every four years; if this does not happen, there will be a vacuum in legal responsibility for management of the on-farm systems and the LTDs will, at least from a legal perspective, not have any AA clients. 102. The financial situation of the LTDs is equally fragile. LTD revenues from users (including both revenue from AAs and significant revenues from hydropower plants) covered only 13 percent of LTD costs 37 (Table 22). In addition to low cost recovery, the LTDs face high costs because of a requirement to build in a 5 percent depreciation charge 38 into their accounts and to pay tax on their property (which remains under state ownership). Given that most irrigation and drainage infrastructure has a life in excess of 20 years, the depreciation charge requirement appears to be excessive. The government is currently considering exempting LTDs from property tax until 2014 (AAs are already exempt until 2012). Two of the LTDs (Alazani-M and Kolkheti-M) are now in serious financial difficulty while the other two (Sioni-M and Mtkvari-M) appear to be in better condition. th Table 22 LTD Cost Recovery (January to November 30 2008) GEL Source: IDCDP Aide Memoire December 2008 Privatization plans 103. The government intends to privatize the LTDs within the next few years. Given the poor condition of the infrastructure, weak financial status of the LTD and inadequate staffing and skills within the LTDs, this is highly ambitious. It is also unclear who the private investors would be and it seems unlikely that there would be much competition for these resources. Regardless of the form of privatization adopted, a 37 Source: Bank IDCDP aide memoire December 2008. Data refers to the average for 3 of the 4 LTDs (Alazani M, Sioni M, Mtkvari M). Cost coverage ranged between 1% and 63%. More than half of the income from users was from hyrdro-power stations. 38 This is considered to be excessive since most schemes will have a life of more than 20 years. 43 package of public financing for rehabilitation and regulatory arrangements will need to be in place before proceeding. These issues are discussed further under recommendations. 3. Seeds 104. The seed industry was deregulated in 2005 when the essential elements of the seed testing and certification system were dismantled. In 2005, the Georgian Government abolished the MOA State Commission of Testing and Protection of Selection Achievements and the MOA Seed and Seedling Quality Control Inspection. Whilst their abolition had been recommended by a report into Capacity Building of Plant Protection, Phytosanitary Inspection, Seed and Planting Material Production and Control carried out in February 2004 by the Bank, the report had recommended that these two MOA bodies be replaced by a much smaller MOA Plant Varieties Rights Office and Seeds Division, which would have responsibility for plant variety protection, national listing of varieties and seed production and seed certification within Georgia. No supervisory body for national listing of varieties and control of seed production and certification has been set up by the Government and consequently the seeds industry is largely unregulated. Seed testing and certification 105. The Law on the Marketing of Seeds and Planting Material of Agricultural and Vegetable and Vegetable Crop Varieties did, up until 2005, provide a general framework that was aligned with EU legislation. It covered the main elements of National Listing, Seed and Planting Material Production, Testing, Certification and Marketing required by the EC Seed and Planting Material Directives. In 2005 and 2006, a number of articles were removed from the law and a number were revised. 106. The revised Law on the Marketing of Seeds and Planting Material of Agricultural and Vegetable and Vegetable Crop Varieties now allows for varieties to be marketed in Georgia without being listed in a National Catalogue of Varieties. There are no longer any requirements for the official testing of crop varieties to demonstrate their agronomic value through Value for Cultivation and Use (VCU) testing or to demonstrate their varietal purity and stability through Distinctiveness, Uniformity and Stability (DUS) testing. Consequently, varieties can now be freely marketed regardless of their likely performance 39. A reference collection of definitive samples of varieties eligible for marketing in Georgia is not being kept. 107. The Law also allows for VCU testing and DUS testing to be carried out by any person accredited by the Accreditation Centre (United National Accreditation Body), in accordance with the requirements and methods of testing approved by the MOA. No organisations have applied to the Accreditation Centre to carry out VCU testing since the Law was revised because no organisations in Georgia have the equipment or the 39 An example of the problems caused by a lack of VCU testing, are the results of two cheap loans made available by the government in 2006 to private seed producing farms, provided in order to stimulate the production of high quality seed. Three seed farms took advantage of the loans and one of these farms imported Basic (Elite) seed of varieties from abroad and multiplied it for the production of first generation certified seed. Most of the varieties imported were found to be unsuitable for use in Georgia and the crops produced were of very low yields. This demonstrates that even experienced seed farms find it difficult to assess the potential quality of imported seed with VCU testing – even less so, small farmers with no knowledge of foreign varieties. 44 expertise necessary to carry out the work. No organisation in Georgia has the expertise to carry out DUS tests according to the UPOV guidelines but DUS reports for varieties that are already registered in another UPOV member can be purchased. 108. The Law of Georgia on Protection of New Varieties of Plants: While the law is aligned with the text of the International Union for the Protection of New Varieties of Plants (UPOV) and Georgia was granted membership of UPOV in 2008 and while the National Intellectual Property Centre is now responsible for granting Plant Breeders’ Rights to New Varieties in Georgia, the removal of articles relating to the requirement for a Georgian National Catalogue from the Seed Law undermines the main purpose of this legislation. 109. Seed Certification: There are no longer any measures in place for the certification of seed; the one seed testing laboratory which had been operated by the MOA Seed and Seedling Quality Control Inspection has closed and it is no longer possible to get seed tested in Georgia according to International Seed Testing Association (ISTA) seed testing methodology. As a result, the quality of the seed marketed in Georgia during the last three years has fallen and commercial crop yields have also gone down. 110. The revised Law on the Marketing of Seeds and Planting Material of Agricultural and Vegetable and Vegetable Crop Varieties also makes it possible for a legal person, accredited by the Accreditation Centre, to certify the quality of seeds and planting stock. To date no one has applied to the Accreditation Centre to certify seeds and planting stock because no-one in Georgia has the expertise to inspect seed crops according to the OECD Guidelines, sample seed lots according to International Seed Testing Association (ISTA) seed sampling methodology. In addition, it is no longer possible to have seed tested for its physical quality in Georgia. 111. As a consequence of these changes, Georgia does not qualify for participation in OECD 40 seed schemes. Implications for domestic production and export 112. The poor quality of seed is one of the main causes of low yield and profitability of crops in Georgia. About 70 percent of seed used is currently farmers’ own saved seed. In an entirely unregulated seed market, the market partially fails because farmers are not provided with the necessary information to allow them to assess seed quality. This means that high quality seed is undervalued and consequently 40 Eligibility for the OECD Seed Schemes depends on a number of technical criteria being satisfied. In particular: 1. The country shall provide a description of the national scheme for the certification of seed and a copy of the national rules and procedures governing the certification of seed. 2. The country shall describe the development of its certification scheme over the previous five years and specify the amounts of certified seed produced during the three most recent years. 3. The country shall have a national list of varieties, the seed of which is intended to be certified under the OECD Schemes in the immediate future. The national list of varieties shall include only those varieties that have been tested and found to be distinct, uniform and stable, following internationally recognised guidelines and in the case of agricultural species, varieties also found to have acceptable Value for Cultivation and Use in at least one country. 45 there is less incentive for seed breeders to invest in essential long term developments such as the maintenance of the purity of existing varieties and development of new varieties to maintain disease resistance. The final outcome is that the market becomes dominated by poor quality seed as is the case in Georgia. Seed is a difficult commodity in that its quality in terms of its germination potential, physical contamination, varietal purity, and value for cultivational use (potential yield and disease resistance) cannot be determined from physical inspection by farmers alone and requires systems to test and certify seed according to agreed standards. 113. As well as affecting domestic production, the absence of seed testing and certification systems means that Georgia is not able to sell seed in Europe, which would require an OECD and ISTA certificates in line with EU marketing standards. 114. Cereals: There are local companies with the capacity to produce high quality pre- basic, basic and C1 seed but they are not able to sell their seed competitively in Georgia and not able to export at all because there are no testing and certification systems in place to demonstrate the quality of their seed. 115. Maize: The problems described in the seed sector affect all crops but are particularly pertinent to self-pollinating crops such as hybrid maize which offer very significant yield advantages over the existing cross-pollinating varieties used in Georgia today. One breeding company and two seed companies are producing certified seed of hybrid varieties of maize but are all finding it difficult to market it because of a lack of certification. 80 percent of the maize seed market in Georgia is still of the old open pollinated non-hybrid varieties. Farmers are multiplying and saving their own seed down to C4 generation. This is likely to be contributing to the very poor average yields of maize, estimated at just 2 tonnes per hectare, whereas average yields of hybrid varieties are estimated at 8 - 10 tonnes per hectare. 116. Sunflower: Similarly for sunflower, 80 percent of the seed sown is of old open pollinated non hybrid varieties giving yields of 0.8 MT/ ha, as opposed to hybrid seeds which are giving 2-3 MT/ ha. 117. Potato: The annual demand for seed potato in Georgia stands at around 80,000 MT, but production of local seed of any quality is only around 600-700 MT. Imports of certified seed is less than 400 MT, which leaves a massive gap for seed potato which is currently filled by poor quality locally produced seed 41. 4. Sanitary and Phytosanitary Control 118. The government recognizes the importance of SPS control and features it prominently in government strategy 42 but Georgia remains non-compliant with: (a) its international obligations as a member of the WTO SPS Agreement, the International Plant Protection Convention (IPPC), the International Organization for Animal Health (OIE); and (b) the very large body of food, animal and plant health law applied by the European Union to imports from third countries. The principal consequences of this non-compliance are that: (i) Georgia does not apply international standards of health inspection and testing to imported foods, feed, veterinary medicinal products and 41 CARE Market Study for Potatoes, Vegetables, Milk and Cheese in Georgia, 2007 42 Basic Data and Directions 2008. 46 plant protection products (of which it is a major importer), thus putting at risk the health and well-being of its human, animal and plant populations; and (ii) Georgia is unable to export processed foods and primary animal and plant products to the European Union Member States (its largest trading partner) and other WTO members. 119. There are serious deficiencies in Georgia’s SPS system, despite long-standing commitments in the medium-term PCA and ENP Action Plans to improve and strengthen these systems. Key weaknesses include: • Food hygiene: the suspension in 2007 and proposed timetable for introduction of existing inspection and enforcement powers. • Animal health: absence of a legal foundation for inspection, traceability, registration of producers and exporters. • Veterinary medicinal products (VMPs): absence of registration of VMPs and absence of monitoring and control systems, including specialised laboratories for detecting residues in animals and animal products. • Plant protection and pesticides: legislation, licensing and control capabilities are not aligned with international and EU standards. • Animal by-products: Legislation cannot be enforced due to lack of capacity in the National Service for Food Safety, Veterinary Service and Plant Protection (the “National Service or NS) WTO Requirements 120. Under the WTO, each country member can decide what SPS measures it will take to prevent or eradicate pests, diseases and unhealthy residues of substance applied to animals, plants and their products. WTO members can apply the same measures to imported goods. However, WTO members must apply their SPS import rules in ways which minimise any negative effects on trade. In particular, WTO members must not use SPS measures that: a) are unnecessary; b) are not science-based; c) are arbitrary; d) constitute a disguised restriction on international trade. To achieve the general objective of facilitating trade while protecting health, the SPS Agreement requires WTO members to observe a number of key principles: a) harmonisation of standards with those of international organisations, specifically, the International Plant Protection Convention (IPCC) dealing with plant health, the World Organisation for Animal Health (OIE) dealing with animal health and the Codex Alimentarius of the EU Commission (Codex) dealing with food safety; b) equivalence (recognitions of other members’ standards); c) definition of appropriate levels of protection (minimum levels of protection for human animal and plant life); d) risk analysis based in international standards; e) recognition of regional conditions (low risk regions as defined by international standards) and adaptation of standards accordingly and; f) transparency of information on SPS measures. Current Commitments and Plans 121. The government’s commitments, specifically those related to meeting the conditions for the proposed EU deep and comprehensive free trade agreement, are laid out in several key documents. The most detailed plans are laid out in the Strategy 47 for Harmonisation of Georgian Legislation with that of the European Union and the National Programme for Harmonisation of Georgian Legislation with that of the European Union. This document was produced during 2002-3 by the Inter-Agency Working Group (IWG), which was established by the Governmental Commission for Promotion of Partnership and Cooperation between Georgia and the European Union (PCA Commission), supported by Georgian-European Policy and Legal Advice Centre (GEPLAC) and updated in 2003. This Plan is still current and forms the basis for later legislative commitments agreed bilaterally between the government of Georgia and the European Union. SPS control is also referred to in general terms in the 2002 EU- Georgia Partnership and Co-operation Agreement (PCA) article 55. 122. The draft MoA Annual ENP Implementation Plan for 2009 is at a very early preparatory stage and yet to be discussed and agreed with the Office of the State Minister for European and Euro-Atlantic Co-ordination; the Ministry of Finance and the Ministry of Foreign Affairs. The draft plan: proposes various SPS related actions during 2009 to increase compliance with international standards, including actions to increase compliance with EU, WTO, SPS standards, OIE standards on animal health, IPCC standards on plant health; proposes adoption of the EU Rapid Response Alert System and proposes membership to the European Plant Protection Organisation (EPPO) and European and Mediterranean Plant Protection Organisation (EMPPO). World Bank Action Plan for the National Service 123. In 2005, the government transferred responsibility for inspection and control from MoA to the NS but the NS is unable to perform these tasks effectively. The World Bank prepared the Action Plan for the National Service for Food Safety, Veterinary Service and Plant Protection in 2007. The plan laid out detailed reforms under eleven main topics which variously apply to the entire NS, to animal health and food safety and to plant protection. These included: legislative reform; structure of the NS; inspections; laboratory capacity; training and human resource development; membership of international organizations; registration and traceability; information and communication; cooperation with the private sector; emergency and contingency planning and preparedness; and national infrastructure. None of the action points recommended in the Action Plan have been implemented either in whole or in part (other than accession to the EU Rapid Alert System, acceptance of plant heath standards used by EU as “equivalent�, and a shift in responsibility for VMP from MoH to MoA). Some specific aspects of reform are discussed below. Legal Reform 124. The 2008 Progress Report by the European Commission stated that the existing laws for Food Safety and Quality and Plant Protection from Pests 1994 provided a workable basis for adopting secondary legislation meeting EU requirements for plant health certification and for control of pesticides and plant pests. The major deficiency lies in the Law on Licensing and Permissions 2005 (which does not provide sufficient powers of entry and proceedings against unhygienic or unhealthy practices) and the Law on Agricultural Quarantine 1997. Both these laws apply to plant, animal and food processing operations. This report recommends further support for development of primary legislation to fill the gaps in the existing laws and to take the opportunity to incorporate inspection and quarantine provisions in the main laws on animal health 48 and plant health. Further legislation and enforcement/withdrawal plans will be needed to give effect to the ongoing review of plant protection active agents, which is expected to progressively reduce the number of EU-permitted active agents from about 500 to 250 from 2009 onwards. Responsibility for SPS Control 125. The Food Security Department of the Ministry of Agriculture is responsible for SPS policy and legislation. The NS is responsible for inspections and controls but does not perform these functions effectively. NS was substantially downsized while being created in 2005, from around 3,000 to about 320 staff. Staff numbers in the veterinary, food and plant inspectorates are currently some 50 percent below planned levels. The NS issues plant health (phytosanitary) and veterinary certificates, but their control and testing systems do not comply with SPS, EU or other international requirements. Georgian plant and veterinary certificates are not currently recognised by WTO members and other importing countries, which is a major constraint for Georgian food and agricultural exports. The Law on Food Safety and Quality, together with the Law on Protection of Consumers Rights, the Law on the Sanitary Code, the Law on Veterinary Medicines and Products and the Law on Plant Protection against Pests, provide NS with powers to inspect and register enterprises producing food, animal and plant products but these powers have been suspended since 2007. State inspectors do not have powers of entry. State inspectors cannot prosecute or serve notice of prosecution for offences under the law; cases have to be transferred to the Financial Police of the Ministry of Internal Affairs or other bodies. Border Controls 126. Contrary to general EU practice, food, veterinary and phytosanitary controls at borders are entirely the responsibility of the Customs Service of the Revenue Service of the Ministry of Finance. Although Customs has recruited a limited number of animal and plant health specialists, its capacity is limited, specifically it: only has the capacity to make documentary checks; does not take samples; has no capabilities for undertaking risk assessment or risk analysis; and has no access to adequate state or private laboratory facilities for identifying and measuring levels of residues of veterinary medicinal products, additives and contaminants, identifying pests and diseases and detecting other health risks (e.g. bacterial contaminations). MoA/NS have retained policy and legal responsibility for developing risk analysis and risk assessment procedures and for notifying diseases and pest occurrences to the international community, without, so far, establishing formal arrangements for training and collecting the necessary information from Customs. 127. The WB Action Plan and later EU assessments (e.g. the 2008 DCFTA overview of action points) point out that Georgia’s decision to transfer responsibility for border inspections from the MOA and its agencies to the Customs Service runs counter to EU and other developed countries’ practices. However, implementation of the earlier transfer has now proceeded so far, it would be more productive to provide technical assistance to Customs and MoA/NS to make the transfer work effectively, than to reverse the measure. There is also a need to strengthen functional and policy 49 oversight of Customs inspection by MoA/NS and to improve compliance with international standards for risk analysis, sampling and inspection. Laboratory Capacity 128. Laboratory testing remains a serious problem for Georgian compliance with international requirements. There is one public official laboratory which monitors a limited number of diseases on a limited number of animals, which has limited capacity for diagnosing animal diseases. Georgia has official access to good modern laboratory facilities for bio-security, established under USA regional policies and budgets for dealing globally with biological warfare and terrorism but these facilities give first priority to sampling and testing for bio-security purposes. The MOA does not have laboratory facilities for testing veterinary medicines and residues thereof or products of animal origin. 129. The Government has sought to transfer as much food testing as possible to private laboratories but it still lacks policies and resources for accreditation and monitoring their reliability. The MoA has introduced a licensing system for private sector laboratories for food safety samples. About 30 are currently licensed, but these, generally, lack the range of capabilities needed for SPOS/EU compliance (e.g. pesticide residue detection, identification and measurement). All samples from border posts (and, presumably, from inspections of enterprises in the food chain, i.e. retail, distribution, storage, manufacture, farm production) have to be sent to private laboratories. The lack of laboratory testing capacity means that the government is currently unable to participate effectively in the EU Rapid Alert System for Food and Feed (RASFF) Industry investments 130. Considerable investment and time will be needed before enterprises are compliant with international health and hygiene standards. The problem is particularly acute for animal slaughter, much of which takes place in unhygienic, unregistered locations. The government must continue its efforts to establish registered and inspected slaughterhouses and to prohibit slaughter in unregistered premises. However, it will take time to establish EU-compliant facilities and to get producers (and consumers) to accept and comply with these requirements. As with certain countries introducing licensing before EU Accession, it may be necessary to set approval standards at lower levels than currently applied by the EU in order to avoid excessive closures and/or continued or increased non-compliance with the law. Initial compliance standards, which might be differentiated on a geographical or regional basis, should be aligned with full SPS/EU standards over a suitable fixed period of time. Meat and meat products from these basic facilities would of course be restricted to the domestic market pending full harmonization. Larger enterprises with realistic prospects of exporting to EU Member States should however be supported to meet standards as soon as possible. Food inspection and registration 131. The Government has so far suspended implementation of the inspection and registration powers provided by Articles 21 and 14 respectively of the Law on Food Safety and Quality. The parallel powers provided by the Law on Protection of 50 Consumers Rights, the Law on the Sanitary Code, the Law on Veterinary Medicines and Products and the Law on Plant Protection against Pests have been similarly suspended. These suspensions will end in January 2010. The NS is preparing for possible implementation of the registration powers but currently has only been able to recruit some 50 percent of the technical inspectors needed. There are inadequate skills in techniques of risk assessment and management, sampling and recording for policy and operational staff in the MOA, NS, Customs and other inspectorates. HACCP 132. Government officials have actively sought information on the introduction of Hazard Analysis and Critical Control Point (HACCP) practices, not only in food production and processing but in fields where HACCP is not yet practised to any great extent in the EU (e.g. pesticide application and residue control). HACCP has obvious attractions for the Georgian government, whose policy is one of minimal regulatory and supervisory activities. However, because HACCP places the main responsibility for implementation on private processors and producers, successful introduction requires a good level of knowledge of the hazards and risks and how to control them, a reasonable standard of health and hygiene practices throughout the industries concerned and substantial state resources for provision of advice and training. Government enforcement resources should concentrate on auditing and inspection at all points in the chain from farm to table. It is unlikely that these conditions will be widely in place for some years. If HACCP is to be introduced, it should be started in industries presenting the highest risks. Other possible criteria for selection of enterprises to be supported in the introduction of HACCP could include, the ability of the enterprise selected to invest in new equipment and building adaptations, the quality of managerial resources available and the willingness and ability to train and monitor its staff. Registration of Private Veterinary Services and Epizootic Disease Control 133. The animal health services in Georgia have undergone some fundamental reforms which have resulted in reduced public sector involvement in the provision of veterinary services. As a consequence, there has been a lack of surveillance and disease control that was reflected in the difficulty that the country encountered in trying to control the outbreaks of African Swine Fever that decimated the domestic swine industry. The public veterinary service is represented by several staff in each of the districts but they lack sufficient resources and authority and a strong legal framework to carry out effective disease surveillance. In addition, there are an estimated 600-700 village-based private veterinarians but they do not have the mandate nor are they licensed to legally carry out private veterinary services for livestock owners, nor to undertake public service contracts, as was envisaged under the reforms. Attempts to deliver public good programs, such as mandatory vaccination, through private sector tendering have not proven to be effective under the current arrangements. The lack of an effective and fully integrated animal health service has inevitably compromised the health and productivity of the dwindling livestock sector, increased the risk of trans-boundary disease and contributes to concerns over food safety and food-borne animal diseases. 51 5. Marketing 134. There are weaknesses in marketing arrangements for most commodities. These include: the absence of well established marketing organizations, weak contractual arrangements between farmers; poor quality, packaging and grading; inconsistency in supply; poor post harvest handling chains resulting in damage and waste; and inability to meet buyers’ requirements in terms of delivery schedules, contracts, timely delivery, and flexible payment terms. Improvements are needed in handling of most of the agricultural commodities. Some examples for specific product groups follow. Dairy Marketing 135. After satisfying home consumption needs for milk, the vast majority of domestically produced milk is sold locally or in the bazaar as matsoni (sour yoghurt) or sulguni type cheese processed by individuals or small groups of 5 or so farmers 43. Wimbildon, a major Russian owned processor, will establish a milk processing plant in Georgia. Processors are almost entirely dependent on imported milk powder because it is cheaper and provides a more reliable supply of consistent quality raw material. 136. Marketing small farmers’ milk to processors is challenging. It requires that there are a sufficiently large number of farmers in one location, willing to sell their milk to processors, to make it worth establishing a cooling tank in the village. Cool transport needs to be put in place and simple testing arrangements set up. Providing price incentives and minimum standards for fat content and bacterial counts, for a large number of producers whose milk is pooled in a single tank, is also problematic, unless farmers agree to work as a single marketing group. Ensuring consistent quality and quantity of supply, in particular an adequate supply of winter milk at a time when animal nutrition is often poor, is a further challenge. 137. These challenges are not unique to Georgia and are similar in many transitional countries with small scale dairy production but the problems in Georgia are exacerbated by weak institutional arrangements for disease control, animals health and food safety. However, there are examples of processors successfully sourcing milk from small producers, such as the medium sized milk plant established in Terjola district in Imereti region, which processes about 5 MTs of milk per day into cheese per day. The SIDA dairy project has also established about 20 milk cooling tanks and estimates that about further 25 have been established by farmers themselves. Replication of these examples would do much to improve small scale milk marketing, and provide a good source of cash for some of the poorest farmers but this will require quite intensive technical support and facilitation which can probably best be provided by donor projects, NGOs or from the processors themselves. Fruit and Vegetable Marketing 138. Georgia is facing difficulties in competing with imported fruit and vegetables primarily from Turkey and to a lesser extent from Armenia, Azerbaijan, Russia, China and other countries and poor marketing arrangements and infrastructure are part of the cause. Direct selling by small individual farmers is expensive and does not provide 43 Market Study for Potatoes, Vegetables, Milk and Cheese, CARE 2007 52 the market with the consistent quality and quantity which it demands. It is also expensive for wholesalers to deal with a large number of small farmers and farmers are in a weak position to negotiate with them. Small farmer marketing groups, which offer a possible solution, particularly for more perishable crops (soft fruit), which require well organized and timely delivery, are uncommon. Poor storage facilities mean that the quality of produce deteriorates rapidly through the winter. Farmers tend to sell produce earlier in the year at lower prices to avoid storage losses and the market becomes even more saturated with imports after the middle of winter. Poor packing also contributes to greater storage and transport losses and inadequate sorting, grading, washing means that some produce does not achieve its potential price. The deterioration of greenhouses means that Georgia is less able to compete in the off-season market. There is therefore, a need for both organizational support and finance for investment in physical infrastructure. 139. CARE undertook a marketing study in 2007 44 which suggests that such investments would create opportunities for Georgia farmers to partially substitute a number of imports examined during the study including: potato imports which are highest in February, March and April from Turkey (and to a much lesser Azerbaijan and Russia); carrot imports which are highest from February to July from Turkey, (and to a much lesser extent Armenia and Azerbaijan); beetroot imports which are highest from January to July from Armenia, Turkey and Russia; onion imports from Azeri small traders which are highest in May and June and from Turkish wholesalers which are strong throughout the year; garlic from China wholesalers and Iran (via Azeri small traders) which are strong throughout the year but particularly so from January to May; and greenhouse tomatoes from Turkey between November and May. 140. There are good examples of how marketing services and infrastructure for fruit and vegetables can be successfully improved in Georgia. The USAID funded AgVantage project is designed to expand production and sale of export-oriented agricultural products. The project identifies markets for Georgian value-added products and then works through the market chain to ensure timely delivery of quality products. The project has established consolidation centres and provided finance and technical assistance to introduce improved processing, cooling and packaging technology. AgVantage stakeholders sell quality greens, onions, apples, mandarins, oranges, pears, peaches, hazelnuts and early potatoes to the domestic as well as existing and newly-opened markets in Ukraine, Armenia, U.K., Estonia and Germany. AgVantage has completed more than 50 fruit and vegetable, processing and export facilitation projects. Wine Marketing 141. The Russian wine embargo forced the wine sector to consider how to re-orientate itself towards new markets. While the scale of the loss was immense, this dramatic shock may serve to accelerate the reforms and investments necessary for Georgia to penetrate new markets in a highly competitive industry. There is some confidence in the future potential of Georgian wine. Major wineries have invested in modern equipment and are investing in land, confident that they can survive the transition 44 Market Study for Potatoes, Vegetables, Milk and Cheese, CARE, 2007. 53 and reach new markets. The draft “Development of the Georgia Wine Strategy and Action Plan�, March 2009, prepared under the World Bank Agricultural Development Project, identifies a comprehensive package of legal, regulatory, marketing, research, educational, and technical issues which need to be addressed. 142. The report recommends that Georgia continues to serve existing CIS markets where Georgian wine is well known and that it simultaneously tries to penetrate new markets, primarily China, Japan, Hong Kong, India, Thailand, Malaysia, Philippines, South Singapore, Taiwan, Brazil and to a much lesser extent EU, UK the US and Canada, where penetration will be more difficult. Given the relatively low incomes in CIS countries, these markets will continue to be for low priced wines. For new eastern European and East Asian markets where Georgian wine is largely unknown, Georgia should price its wine at a level which will encourage as many people as possible to try Georgian wine while maintaining a distinction from the lower end of the market, which implies supplying mid priced wines at around $10-15 per bottle. 143. Ensuring the integrity of the Georgian brand and promoting it internationally will be critical for future development. The report proposes the establishment of a Wine Standards Board to ensure industry compliance with the law, implement a label integrity program and to inspect wineries and a “National Wine and Brandy Making Bureau� to undertake market intelligence and brand promotion. It also indicates that the current wine law is unclear in places and needs to be written based on EU wine law, to provide a proper legal foundation for the Wine Standards Board to operate in terms of classification of wines, enological 45 practices, record keeping and labeling. Counterfeit Georgian wine is a major problem and once established, the National Wine and Brandy Making Bureau should commission a brand audit in export markets to track the origins of counterfeit wine. 144. Penetration of new markets will require that the large number of appellations will need to be simplified to be easily understood by consumers not familiar with Georgian wine. There are currently a large number of small appellations. These should be regrouped under fewer appellations, the border for which should reflect the unique soils and microclimate of the appellation. While some smaller appellations can be maintained, these need to be grouped under the newly defined main appellations. Additionally, wines can be labeled under regional wine categories. Once the categories of wine have been rationalized and an image identified for Georgian wines, these will need to be promoted through inexpensive social networks, product placement, as well as through representation at carefully selected global trade shows. Consolidation of small wineries, to ensure that wineries are able to meet the minimum quantities required by buyers and joint ventures with large multinational wine producers, would both help Georgia to reach mass wine markets. 145. These marketing initiatives will need to be complemented by some long term investment in the technical aspects of viticulture and wine making. While most of the large wineries are well equipped, some smaller wineries will need to invest in new processing equipment and tanks. Processors should seek to achieve HACCP and ISO certification, as international food safety standards will increasingly be required in 45 Enology means wine making. 54 new target markets. Long term investments in education in viticulture and wine making will be necessary to maintain a cadre of skilled growers and processors. This could be achieved through establishment of a wine college offering a 3 year Bachelor of Science course and a wine business course, in cooperation with an international business school. Greater investment in research and attracting a new generation of young researchers will also be important. There is also a lack of suitable planting material to replace old vines and investment in clonal selection is needed to generate new planting material. H. Rural Infrastructure 146. Rural infrastructure including electricity, gas, potable water, rural roads, telecommunications, irrigation and drainage infrastructure is a major constraint which needs to be addressed to ensure basic human well being, to enable rural business to go about their daily operations, to enable access to markets and information and so bring about diversification of the farm and non-farm sectors. These issues are not examined in this study in detail but some of the key findings of the study entitled, “Rural Infrastructure in Georgia, Improving Service Delivery� (World Bank 2006) are summarized below. Condition of rural infrastructure 147. A comprehensive assessment of rural infrastructure is provided in, “Georgia, Rural Infrastructure in Georgia, Improving Service Delivery, Volumes One and Two� World Bank 2006. The report mapped access to electricity, gas, potable water, roads, telecommunications and irrigation and drainage throughout the country and drew the following conclusions regarding the condition of rural infrastructure in Georgia 46. • Electricity: While 98% of the population had access to electricity, availability was low with 32% of the population having less than 2 hours access per day. The 23% of the population supplied by public companies (94% of the total population) were partially dependent on generators. • Gas: 21% of households had access to gas and 81% were within 50Km of a gas pipeline. Adjara, Guria and Samegrelo had no access to gas. • Potable Water: 96% of households and 61% of markets and schools had access to potable water. 27% of households were supplied from a central supply but half of these were partially dependant on another source. • Telecommunications: While many communities had access to mobile networks, only 7% of households had mobile telephones. Only 26% of communities had working telephone lines to houses. 42% of communities had public telephones. 73% of telecommunications infrastructure required immediate repair. • Transport: Road density in communities varied from 3 to 19 metres/ person. The condition of roads in most communities was poor. The majority of roads were unpaved. Only 5% of roads were repaired within the last five years and 15% were repaired more than 15 years ago. 46 Irrigation and drainage is dealt with separately under section IIIG of this study. 55 Cost of rehabilitation 148. The report estimated the cost of basic rehabilitation of rural infrastructure at about US$1 billion at the time, including US$212 million for lifeline roads, US$439 million for gas, US$87.3 million for electrification, US$46 million for telecommunications, US$ 47 million for potable water. Prioritization of Infrastructure Investments 149. The 2006 study proposed a rural infrastructure assessment toolkit, which included a decision matrix. The matrix provides a means of prioritizing infrastructure investments using criteria including, community preferences and ranking, poverty alleviation potential, economic growth potential, employment potential, cost effectiveness, affordability and sustainability. The matrix reveals that when emphasis is placed in economic growth and poverty alleviation criteria, electric power and drinking water are the priority investments. 150. The 2006 study revealed that if communities’ ranking of the importance of alternative infrastructure investments is aggregated by region, the communities’ prioritize electricity, gas and roads and attach less importance to potable water, irrigation and drainage. However, more importantly, the study emphasized that there are differences in the priorities of different regions and differences between the priorities of different communities within each region. It is therefore important to give individual communities a voice in selecting public investments, particularly if the community is expected to contribute to investment or recurrent costs. So, although a low proportion of communities in most regions identified potable water as the first priority, they were identified as a first priority by a high number of communities Kakheti and Racha. Similarly, irrigation and drainage was identified as a first priority by many communities in Samtskhe-Javakheti and Shida-Kartli regions 47. Ownership, management and financing 151. In designing infrastructure rehabilitation, the government needs to examine options for ownership, management and financing investment and recurrent costs. 152. Ownership and management: The decision on whether public investment and ownership of infrastructure is appropriate should be based on whether the infrastructure provides an element of public good. In such cases the private sector is unlikely to be able to capture externalities in their charges and the service may not be financially viable for them. The decision on whether this infrastructure should be owned by national or local government should depend on whether the infrastructure primarily serves local or national interests (roads are a very simple example). The two tier government structure which emerged from the 2005 Law on Self Government (LSG) 2005, provided for a greater role for local government in decision making, 47 Reference Table 11“Georgia, Rural Infrastructure in Georgia, Improving Service Delivery, Volumes One and Two� World Bank, 2006. Caution should be exercised in interpreting these results. For example, if potable water was not identified as a first priority by any community in a region it would show a score of 0% in the table. This does not mean that potable water is not important to the community - they may have been seen it as an important second priority but this would not be reflected in the table. 56 management and financing of rural infrastructure 48. Community ownership may be appropriate where the infrastructure serves a specific community. Even in cases where infrastructure is publically owned, there may still be advantages in contracting out management to private service providers or delegating responsibility for management to community based organizations. 153. Financing: There is a very high willingness to pay for services, even amongst low income groups. For example households earning less than 100 GEL per month in 2006 and currently receiving less than 2 hours of electricity per day indicated that they were willing to pay up to 8 GEL per month for electricity, while households which were dependent on water vendors indicated a willingness to pay up to 25 GEL per month. These high levels of potential contributions are important for maximizing the coverage of public investments and ensuring sustainable recurrent cost financing by the community. 154. The Municipal Development Fund (MDF) has been central to supporting the implementation of these arrangements for both donor and government funded rural infrastructure investments. I. Prioritization of Policy Challenges and Constraints 155. Section III has examined a wide range of challenges and constraints. It is useful to consider which of these represent the key limiting factors to growth of the rural economy. In practice, growth is constrained by a combination of inter-related factors rather than a single limiting factor, nevertheless, the policy challenges and constraints can be broadly prioritized as follows. i. Maintaining macro-economic stability is the first priority for government and will have a greater influence on growth of the rural economy than any individual rural development policy. Macro-economic stability is critical to maintaining domestic demand, investment, savings and public investment. Specific rural development constraints therefore need to be undertaken within the limits of fiscal discipline required for macroeconomic stability. ii. Financial sector recovery following the financial crisis is the second priority for government. It is critical to overall economic recovery and increasing domestic demand for rural output. Therefore, while many small rural households are not borrowers from formal lending institutions, they will be directly affected by the health of the financial sector. For small rural businesses, access to finance is a major binding constraint. iii. Maintaining a competitive exchange rate and trading arrangements in terms of tariff and non tariff barriers is important not only to farms and agribusinesses serving export markets but also to those competing on domestic markets, which are currently dominated by imports. Georgia has been very progressive in terms of liberalizing its markets but until its trading partner reciprocate in trade negotiations, it will be difficult for Georgian farmers to compete with them. 48 69 LSG units emerged from the reorganization which included 59 former raions, 4 district and 4 special status cities. 1,100 small local government units were abolished (Source. “Georgia, Rural Infrastructure in Georgia, Improving Service Delivery, Volumes One and Two� World Bank, 2006.) 57 iv. Rural infrastructure including electricity, gas, potable water, rural roads, telecommunications, is a major constraint which needs to be addressed to ensure basic human well being, to enable business to go about their daily operations, to enable access to markets and information and so bring about diversification of the farm and non-farm sectors. The prioritization of infrastructure investment can best be done by the communities themselves and will be specific not only to regions but to specific communities. v. Agricultural services. a. Seeds: Insufficient importance has been attached to this constraint. It could be argued that this is the most important agricultural service constraint because without good seed, investments in agricultural services will not achieve their potential returns. b. Irrigation and Drainage: Government has rightly prioritized this as one of the most important agricultural service constraints. There is some urgency to address this issue because unless the ongoing rehabilitation program is accompanied by appropriate institutional and financial arrangements to ensure adequate recurrent expenditure on maintenance, the condition of the system will deteriorate further, making rehabilitation more expensive in future. c. Machinery Services: This constraint is equally important as irrigation and drainage but one which should primarily addressed by the private sector. Now that government has rightly decided to cease the government machinery program, stimulating private sector financing of machinery services is an urgent challenge. d. Sanitary and Phytosanitary Control: Establishing sanitary and phyto-sanitary services and regulation is important not only to reach EU and other new export markets but also because of the public health consequences of poor regulation SPS standards. e. Poor marketing infrastructure including, collection, storage and distribution facilities is a constraint, particularly for higher value crops and dairy products. This is a constraint which needs to be addressed through private sector investment but this will only come about once the aforementioned constraints have been addressed. f. The provision of advisory services is not a limiting factor for farmers who do not have access to finance, basic public services and infrastructure but will become a limiting factor once these constraints have been addressed. vi. Weaknesses in the land market are not a major constraint at the moment but it is important to prepare for evolution of a more active land market as and when demand for land increases. The small size and fragmented nature of farms are both constraints to farm productivity but ones which can be resolved by the market once the competitiveness of the sector increases and more non-farm employment opportunities emerge. 58 IV. POLICY OUTCOMES 156. This section examines the overall impact of the policies and constraints discussed in the previous section on the rural economy, in terms of rural incomes, poverty and employment and then considers its affect on the structure and performance of the farm and non-farm sectors. A. Rural Employment, Incomes and Poverty Rural Population and Employment 157. There is no evidence of migration from rural to urban areas as the rural population has remained relatively constant (Figure 18). There are also no signs of a shift of labor from the farm sector to the non-farm sector within rural areas, as the percentage of the workforce employed in agriculture has remained fairly constant, declining from 54.9 percent in 2003 to 53.4 percent in 2007. Furthermore, the private land market is not very active suggesting that there is no significant migration out of farming. Figure 18 Comparison of the Regional Distribution of the Population in 2003 and 2009 Source: Statistical Yearbook 2008 Rural Poverty and Incomes 158. The World Bank Poverty Assessment 2008 examined changes in rural incomes and poverty between 2003 and 2007 using the 2003 Household Budget Survey and the 2007 LSMS. A direct comparison of poverty rates in 2003 and 2007 was not possible because of the incompatibility of data used in the two surveys but the analysis provides a comparison of rural monetary incomes and a comparison of sources of rural income. 159. Rural monetary incomes increased by 55 percent from 94 to 146 GEL per household per month (2007 constant prices) between 2003 and 2007 (Table 23). There were large regional differences in the changes in rural monetary incomes during this period and Mtshketa-Mtianeti, Kakheti, Shida Kartli regions experienced negligible or negative growth (Table 23). 160. There was a marked change in the share of various rural monetary sources of income between 2003 and 2007 (Figure 19). In all regions, public transfers increased substantially from an average of 9.5 to 52.1 GEL per household per month (constant 2007 prices). Salaried incomes also increased substantially from 31.7 to 53.0 GEL per household per month (constant 2007 prices) although there were differences 59 between changes in each region with Kvemo Kartli, Adjara and Guria benefiting much more than other regions (Table 24). This was due to an increase in both non-farm wages and to a lesser extent farm wages 49. 161. Agricultural wages increased from 112 to 126 GEL per month (2006 constant prices) or 12 percent between 2003 and 2006 as the agricultural labor force declined but at a lower rate than wages in the economy as a whole, which increased from 160 to 198 GEL per month or 27 percent. The increase in agricultural wages had a disproportionately lower impact on the poorest income groups, for which salary and wage employment represented only 7 percent of their total income in 2007, which is low at 98 GEL per household per month compared to GEL 260 for all rural households50 . Table 23 Georgia: Change in Monetary Income of Rural Households GEL/Household/ Month (2007 prices) 2003 2007 % Change Monetary Income 93.9 146.0 55.5 Salary income 31.7 53.0 67.2 Self-employment 31.3 34.2 9.3 Remittances 6.6 3.0 -54.5 Internal private transfers 14.4 3.5 -75.5 Property rentals 0.5 0.2 -64.7 Public transfers (incl. pensions) 9.5 52.1 449.0 Monetary Income by Region Emeriti 86.5 156.6 81.1 Samegrelo 70.4 133.0 88.9 Samtskhe-Javakheti 61.4 125.9 104.9 Kvemo Kartli 105.8 138.0 30.5 Ajara 81.5 191.1 134.5 Guria 85.3 137.9 61.7 Mtshketa-Mtianeti 188.0 129.0 -31.4 Kakheti 112.9 109.6 -2.9 Shida Kartli 89.4 90.6 1.3 Source: World Bank Surveys, 2003 and 2007. 49 Poverty Assessment 2008 50 The Poverty Assessment 2008 was only able to establish a comparison of monetary incomes not non monetary incomes from the 2003 Household Budget Survey and 2007 LSMS survey 60 Figure 19 Comparison of Sources of Rural Incomes in 2003 and 2007 Source: Poverty Assessment 2008, World Bank Table 24 Changes in Regional Sources of Monetary Rural Incomes 2003-2007 Change in GEL / Household per Month (2007 prices) Public Salary Self- Remittances Private Transfers Employment Transfers Emeriti 40.9 27 13.1 -3.8 -7.1 Samegrelo 43.7 29.1 20.4 -13 -18 Samtskhe-Javakheti 35 -0.6 48.1 -12.2 -5.8 Kvemo Kartli 34.8 32.1 -30.3 -2.2 -0.7 Ajara 27.6 53.9 28 5.9 -6.3 Guria 40.4 33.1 -0.3 2.8 -23.3 Mtshketa-Mtianeti 35 -56.2 -13 -2.5 -19.7 Kakheti 42 -11.9 -16.6 -2.1 -15 Shida Kartli 35.3 -3.1 -14.1 -1.5 -13.7 Source: Poverty Assessment 2008, World Bank B. Farm Sector Farm Structure 162. Stagnant farm structure is a sign of the serious constraints and low profitability within the sector. The farm structure which emerged from privatization resulted in small fragmented farms. In a vibrant rural economy, there would have been strong incentives for the weaker farmers to seek alternative employment and for the stronger farmers to seek economies of size and consolidate land plots by leasing or buying land from those leaving the sector. While some larger leased farms emerged from the second phase of land privatization (averaging 12.5 ha) and the Agro 100 program and while some of the wineries now appear to be buying up land, these represent a small percentage of total agricultural land. The relatively low level of land sales and low land prices indicate low demand for agricultural land. Of greater concern is that a significant amount of land has been abandoned but the employment figures do not suggest that this is due to farmers leaving the sector for non-farm employment. 61 Performance 163. The poor performance of the agricultural sector since 2003 and sharp contraction in agricultural output in 2006, has contrasted sharply with impressive consistent growth in other sectors, up until the global recession and the August 2008 war with Russia which affected all sectors. Agricultural sector GDP has significantly declined as a percentage of GDP from 19 percent in 2003 to 12 percent in 2008 (Figure 20). While a decline in the share of agricultural GDP in total GDP may be expected in growing transitional economy, absolute growth in the sector has been weak. Agricultural sector growth has been erratic (ranging between -8 percent and 12 percent averaging 1.3 percent between 2003 and 2008) but the low level of output following the sharp decline in 2006 has been sustained (Figure 21). Low output and negligible migration of labor out of the sector are reflected in low and stagnant labor productivity in agriculture compared to other sectors (Figure 22). Figure 20 Comparison of Agricultural GDP and GDP Source: Department of Statistics Website Figure 21 GDP Agriculture, Forestry and Fishing Source: Department of Statistics Website 62 Figure 22 Real Value Added (VA) per Employee, by Sector (as proxy measure of labor productivity) 25 22.2 20 19.0 17.0 15.8 15.1 GEL thousand 15 13.6 12.0 10 9.1 7.5 6.2 6.5 5 3.3 1.6 1.7 1.7 1.8 1.6 1.7 0 1998 2003 2004 2005 2006 2007 Agriculture Services Industry Average VA per employee Note: Value-added numbers are based on national accounts. Source: Poverty Assessment 2008 164. The decline in the sector in 2006 was consistent with substantial disinvestment in the sector, in 2006, with crops areas and livestock numbers declining dramatically 51. This is most likely attributable to the impact of the Russian trade embargo on the sector and the economy as a whole, rather than any specific agricultural policies, although the weaknesses in the sector will have weakened the sector’s ability to deal with the shock. The wheat area declined by 40 percent from 98,000 ha in 2005 to 59,000 ha in 2006 and the maize area declined by 34 percent from 195,000 to 129,000 ha. Other higher value crops also declined to a similar extent (Figure 23). Ruminant livestock numbers declined by 7 percent and pigs declined by 25 percent in 2006 and then by a further 68 percent in 2007 after the African Swine Fever outbreak. While the trade embargo primarily affected high value products such as wine, citrus, fruit and vegetable exports, the impact on rural incomes will also have affected domestic demand for other food products, triggering the decline in other crop areas and livestock 52. 51 While the statistics show a significant decline in the cropped area, it is unclear how much of this change is due to a change of the methodology for data collection used by the Department of Statistics. 52 The increase in food and input prices in 2007 and early 2008 may, perversely, have also negatively affected small farmers who are net consumers of food but would have benefited larger farmers who are net producers. 63 Figure 23 Sown Areas Source: Statistical Yearbook of Georgia 2008 Figure 24 Livestock Numbers Source: Statistical Yearbook of Georgia 2008 165. Crops yields have been erratic but were particularly low in 2006. Changes in yield in any single year should be interpreted with caution because of climatic influences but the general trend in yields over the period 2003-2006 has been slightly negative for most crops with a slight recovery in 2007, except for vegetables, potatoes and root crops, which declined substantially from 2003-2006 before recovering in 2007 (Figure 25). This trend has been generally consistent across the regions. 64 Figure 25 Crop Yield Trends Source: Statistical Year Book of Georgia 2008 Competitiveness and Trade 166. Georgia has found it difficult to compete with its trading partners in meeting domestic demand for beef, milk, fruit, vegetables and root crops. In the face of this competition, Georgia has managed to significantly increase its food and beverage exports from US$147 million in 2003 to US$249 million in 2007 but this success has been over-shadowed by much greater increases in imports of food and beverage, which grew from US$182 million in 2003 to US$762 million in 2007. Even before the Russian trade embargo in 2006, Georgia had successfully started to increase its share of exports to EU countries (up from 10 percent in 2002 to 40 percent in 2007) and reduce its dependence on old CIS markets (down from 83 percent in 2002 to 54 percent in 2007). The export success has predominantly been in nuts, wines and mineral water to CIS countries and the EU. The influx of imports has been in a very wide range of products from Turkey (particularly for fruit and vegetables) and also from Russia, Ukraine, Armenia, Azerbaijan, Iran, China, Kazakhstan, EU, and Brazil. Trade trends are shown in Figure 26 to Error! Reference source not found.. 167. Georgia’s lack of competitiveness is due to a combination of factors described in this report including: inequitable agricultural trade tariffs imposed by its trading partners, particularly with Turkey; weak rural credit markets; limited availability of private 65 sector finance for machinery and a still nascent network of machinery dealers and contractors; a poorly regulated seed market and consequently low availability of quality seed; the poor condition of irrigation and drainage infrastructure and weak institutional arrangements for management of off-farm and on-farm systems; limited veterinary and advisory services; and poor marketing infrastructure, consolidation, storage, cooling, grading and packaging arrangements throughout the domestic and export market distribution channels. Many of these problems are exacerbated to some extent by small farm size and fragmentation, which mean that such farms are expensive to deliver services to and more difficult for buyers to conclude contracts with. However, the constraints described affect all farm sizes and small farm size is not the key limiting factor in most cases. In any case, until there are greater rural off- farm employment opportunities, consolidation of farms is unlikely. Figure 26 Food and Beverage Exports Source: Customs Department Estimate Figure 27 Share of Food and Beverage Exports Source: Customs Department Estimate Figure 28 Food and Beverage Imports Source: Customs Department Estimate 66 Figure 29 Food and Beverage Trade Source: Customs Department Estimate C. Non-Farm Sector 168. The MED Department of Statistics data on registered SMEs in Tbilisi and the regions described in section I, provides some indication of trends in enterprise numbers, changes in ownership and legal form over the period 2003-2007. No comparable data for 2003 is available on enterprise turnover but trends in enterprise numbers provide some indication of the impact of policy reforms on enterprise development. Number of enterprises 169. The total number of registered enterprises have increased rapidly following the far- reaching economic and trade reforms since 2004. The growth in enterprise numbers has been greatest in Tbilisi but still substantial in the regions, including some of the poorer regions. Thus, between 2003 and 2007, the number of registered enterprises in Georgia increased from 91,982 to 207,598, by about 126 percent, at an annual average rate of over 23 percent (Table 25). The share of total enterprises located in the regions has decreased from 65 percent in 2003 to 51 percent in 2007 (Table 25). All regions have experienced considerable growth in enterprise numbers including in some of the poorer regions (Table 25). Growth during this period was greatest in Samegrelo-Zvemo Svaneti (215 percent), Adjara (147 percent), Shida Kartli (134 percent), Guria (130 percent), and Kvemo Kartily (126 percent). 67 Table 25 Growth in Number of Registered Enterprises by Region Source: Adapted from Entrepreneurship in Georgia 2008, MED, Department of Statistics Enterprise ownership 170. Growth has been greater in legal entities than in individual enterprises. The number of enterprises registered by individuals, has grown faster than the number of enterprises registered as legal persons and increased from 65 percent in 2003 to 71 percent in 2007 (Table 26) 53. Table 26 Registered Enterprises by Ownership, 2003-07 Source: Entrepreneurship in Georgia 2008, MED, Department of Statistics Enterprise business activity 171. Growth has been greatest in enterprises engaged in trading. Between 2003 and 2007, the number of trading enterprises increased from 59,678 to 159,186, by about 167 percent, at an annual rate of over 40 percent (Table 27). The growth in number of enterprises in other sectors such as manufacturing (from 10,181 to 13,389), construction (from 2,136 to 3,961) and transport and communications (from 5,192 to 53 No disaggregation of data by Tbilisi and the regions is available. 68 6,963), was impressive in absolute terms although their respective shares in the total number of enterprises declined as a result of the massive increase in the number of trading enterprises (Table 27) 54. Table 27 Number of Registered Enterprises (small, medium and large) by Business Activity, 2003-07 Source: Entrepreneurship in Georgia 2008, MED, Department of Statistics 172. The MED Department of Statistics, Small and Medium business in Georgia, 2008 examines changes in enterprise performance and changes in the business environment between Q4 2007 and Q4 2008 based on a sample of 7500 enterprises, selected from a database of 33,000 entities, comprising large (1400), medium (3000) and small (3100) enterprises. The key findings of the survey for the sample SMEs included were as follows: • Turnover and Investment. The total turnover of the SMEs during Q4 of 2008 (GEL 767.9 million) was 13.7 percent less than in Q4 2007 (889.4 million). Although in nominal terms, the investments in fixed assets made by SMEs in Q4 of 2008 (GEL 36.1 million) were slightly higher than in Q4 of 2007 (GEL 35.1 million), in terms of proportion of SME investments to total investments in the business sector, these were lower at 13.4 percent in Q4 of 2008 than in the Q4 of 2007 at 16.2 percent. Small enterprises invested more relative to medium-size enterprises; • Employment and earnings. The number of people employed by the SMEs at 130,982 during Q4 of 2008 (39.3 percent of total business sector) was lower than in Q4 of 2007 at 138,092 (42.1 percent of the total business sector). The number of people employed in small enterprises was higher in Q4 of 2008 than in Q4 of 2007. Thus, the loss of jobs was greater in medium enterprises. In nominal terms, the monthly earnings in SMEs at GEL 366.7 in Q4 of 2008 were higher than those in Q4 of 2007 (GEL 300.9). • SME Sustainability. The SME sector growth in response to the overall improvement in the business environment between 2003 and 2008 has been quite sustainable. During Q4 2008, of the 7500 SMEs surveyed, those in existence for more than 10 years accounted for 25.5 percent of the total; those for 5-10 years accounted for 28.2 percent; those for 3-5 years accounted for 25.7 percent; those for 1 to 3 years accounted for 12.7 percent; and those in existence for less than one year accounted for 5.6 percent. • During Q4 2008, 12.4 percent SMEs surveyed saw the business environment worsening to some extent, especially following the August 2008 conflict with Russia coupled with a 54 No disaggregation of data by Tbilisi and the regions is available. 69 broader slow down in the global economy. Only 15 percent of SMEs surveyed perceived an improvement. The perception of a deteriorating business environment mainly originated in SMEs in construction, mining, trade and real estate. However, according to survey data, in Q4 of 2008, nearly 85.1 percent of the SMEs surveyed, intended to continue their activities, similar to the response in Q4 of 2007. 70 V. RECOMMENDATIONS 173. This section examines the extent to which policy makers should prioritize the farm and non-farm sectors and then presents some specific recommendations for reform in detail. A. Prioritization of Farm and Non-farm Sectors 174. In the short term, the priority is to increase competitiveness in the agricultural sector, which is critical for rural growth. Increased competitiveness in the agricultural sector is a pre-requisite to growth of rural non-farm sector in the medium term, for several reasons. Firstly, from the supply side, the rural economy is not well equipped to rapidly shift to the non-farm sector. The rural non-farm sector is narrow and dominated by trade. Secondly, from the demand side, the demand for rural non-farm sector goods and services will primarily come from the rural households who are highly dependent on farm incomes (40 percent of total income 55). However, until farm incomes are raised substantially above subsistence levels, rural expenditure will continue to be dominated by low value food products, rather than products and services from the non-farm sector. Finally, development of agriculture will stimulate the non-farm sector through strong linkages with upstream and downstream rural businesses. 175. The Farm Sector: The exposure of the agricultural sector to international competition, following the trade reforms since 2005, will drive increases in efficiency but the government needs to put some basic foundations in place to allow the agricultural sector to respond to this competition. The agricultural sector is not sufficiently equipped to respond to the intense competition brought by changes in Georgia’s regional trade relations and liberal trade policy and a dramatic shift of resources from the farm sector to the non-farm sector is unlikely in the short term. Improvements in agricultural competitiveness require some basic foundations to be put in place, including improved access to rural finance and the provision of the essential public services for agriculture described below. This can be achieved through more efficient allocation of the current agricultural budget and does not imply a reduction in spending on non-farm sector or sector neutral public investments. 176. The Non Farm Sector: The rural non-farm sector can play an increasingly important role in the rural economy in the medium term and potentially absorb excess labor from the agricultural sector but this is unlikely to happen quickly. The government’s success in improving the business environment, the government’s improved credit program and investment in rural infrastructure have already contributed to substantial growth in the non-farm sector but there is a need for diversification. The government’s reform program should focus on promoting diversification of the rural non-farm sector, which is currently dominated by trade, particularly in imported goods, into other agriculturally related businesses such as food processing, transport and storage, as well as other types of business such as repair, manufacturing, 55 Poverty Assessment 2008 71 construction, services and tourism. This will require further improvements in the availability of rural finance and continued investment in rural infrastructure, which will benefit all rural sectors. B. Recommendations for Reform 177. The reform recommendations can be categorised into five areas summarized below. • Financial Services • Agricultural Trade • Rural infrastructure • Agricultural Services • Land Market 178. Table 28 prioritizes the recommended reforms. While many of these can be implemented simultaneously, it is useful to recognize the relative importance of each of the recommendations. Table 28 also summarizes the implications of each recommendation for public expenditure: some will reduce public expenditure; some require only legislative changes and limited public expenditure; some require only some initial public investment and a declining public contribution to recurrent costs; and others require long term public funding. Table 28 Prioritization of Recommended Reforms and their Implications for Public Spending Recommendation Priority Public Public investment recurrent spending spending requirement requirement 1. Financial Services Provide a credit line to financial institutions for SME lending High High Low / short and loan restructuring ( including for leasing and machinery) term Amend the legislation on lease finance and taxation of lease Medium - - companies. 2. Agricultural Trade Examine opportunities to negotiate improved trade tariffs OF High - - trading partners. 3. Rural Infrastructure High / long term for Electricity, gas, roads, potable water, telecommunications High High government systems construction and rehabilitation and establish of owned public or community based ownership, management and Community financing arrangements. Specific Low / declining for community owned 4. Agricultural Services Further shift public spending away from private sector functions in the agricultural sector. Reallocate public spending to and further reform the legislative framework for, essential public services in the agricultural sector 72 4.1 Machinery services: Terminate the government High Medium - machinery program (as planned) and support private sector financing of machinery services through an existing or new credit line to financial institutions 4.2 Irrigation and drainage off-farm system: Delay High High High / privatization of the LTDs and prepare the financial and declining regulatory aspects of a public private partnership with LTDs before privatization. Or maintain the LTDs under public ownership. Invest in rehabilitation of the off-farm system. 4.3 Irrigation and drainage on-farm system: Restart capacity High High Low / building of AAs and invest in rehabilitation of the on-farm declining system. 4.4 Seeds: Align legislation with EU marketing regulations. High Low Low Establish a national list of varieties. Invest in skills and facilities for VCU testing, DPU testing, seed certification and seed inspection. Aim to acquire ISTA and OECD seeds scheme membership in the medium term. 4.5 SPS: Align legislation with EU standards. Conduct NS Medium Low Low/ institutional reform in line with WB 2007 action plan. declining Establish laboratory testing and inspection capacity. 4.6 Veterinary services: Reform the law covering veterinary Medium High High/ service. Upgrade veterinary services in line with international declining OIE standards based on the OIE gap analysis. Establish disease control strategies. Invest in development of private vets and public services contracts with private vets. 4.7 Marketing services: Support replication of donor project Low Low Medium/ examples of supply chain development. Examine possible declining public investment to support the establishment of wine sector marketing organizations as outlined in the draft wine sector study, 2009. 4.8 Advisory services: Establish performance based public Low Low Low service contracts with private service providers for advisory services. 5. Land Market 5.1 Land title mapping: Identify those areas where there may Low Low Low be inaccuracies in mapping and where there may be substantial land market activity in future. 5.2 Land valuation: Develop skills and institutional Low Low - arrangements for land valuation 5.3 Maps: Produce comprehensive 1:10,000 maps as a basis Low Low - for land use and rural development planning 5.4 Land consolidation: Pilot and develop skills in voluntary Low Low - land consolidation 179. The recommendations are discussed below in detail, except for rural infrastructure, which is not addressed in depth in this report. 73 1. Financial Services Provide a credit line to private financial institutions for SME lending and loan restructuring. 180. Examine whether a line of credit from an international financial institution to commercial banks - through the National Bank or MOF - could help the affected banks to meet their short and medium term liquidity requirements and facilitate restructuring of loans or provision new loans to SMEs. Such a credit line would provide much needed breathing time to SMEs to stay in business. The recent transfer of the government’s cheap credit program from the MED to administration by PFIs is a positive move in this respect and will also help rural borrowers establish credit histories with PFIs. Amend the legislation on lease finance and taxation of lease companies. 181. The expansion of leasing could contribute to greater provision of rural finance for agricultural machinery contractors, agro-processors and other rural businesses. While in the current financial sector climate, it is unlikely that substantial lease finance will be made available to rural areas, it would be sensible to prepare for the future expansion of lease finance. This would contribute to the provision of private sector finance for machinery services. The current law on leasing needs to be amended to treat leasing companies as financial service companies not product delivery companies. Specifically, the requirement for leasing companies to charge VAT on the interest portion of monthly installments from the lessee, needs to be re-examined. 2. Agricultural Trade Examine opportunities to negotiate improved trade tariffs with trading partners. 182. Re-examine the trade tariffs in the main countries with which Georgia trades agricultural produce, in particular those with which Georgia has or is currently negotiating free trade agreements. Identify opportunities to reduce trading partners’ tariffs or to increase quotas for preferential tariffs under free trade agreements. Negotiations should also recognize the overall support to the agricultural sectors in these countries in the form of direct support through production and other subsidies, which are considerable in many cases. 3. Agricultural Services Further shift public spending away from the funding of private sector functions in the agricultural sector. 183. The government has pursued a liberal, pro-market approach in most aspects of economic development, dismantling any government intervention in private markets and using public investment to correct market failures, provide public goods or to provide social safety nets. In contrast, public spending in the agricultural sector has not adhered to these principles. Although there has been a shift in public spending in agriculture away from direct support to farmers in the form provision of inputs and sub sector specific support programs, in 2009, fifty percent of the MOA budget is allocated to purchase machinery. This represents substantial public intervention in what is a purely private market, while there is very limited public funding for a number of critical public services, which are unlikely to be provided by the private 74 sector. The government should review its public expenditure program and shift funds previously allocated to the machinery program into other essential services discussed below. Reallocate public spending to and further reform the legislative framework for, essential public services in the agricultural sector. 184. It is important that the agricultural sector regains its competitiveness in international markets by increasing yields, improving quality, reducing marketing costs and increasing market access. This will require substantial revisions to the existing public expenditure program in agriculture as well as some legislative reforms to provide essential public services discussed below. These reforms have implications for public expenditure: some will reduce public expenditure; some require only legislative changes and limited public expenditure; some require only some initial public investment and a declining public contribution to recurrent costs; and others require long term public funding. Major improvements could be achieved within the existing the MOA budget without creating a long term burden on the budget. Machinery Terminate the government machinery program (as planned) and support private sector financing of machinery services, through existing or new credit lines to PFIs. 185. The government has rightly identified the lack of machinery as a key constraint in the agricultural sector but has addressed a failure in the financial market, through intervention in the machinery market. The government’s expected termination of the machinery program at the end of 2009 is well justified following reasons: • The government does not need to be involved in the procurement and distribution of machinery. The existing network of dealers is able to fulfill this function. Georgia has established a good business environment for importers and the government has helped several major international suppliers to establish dealerships in Georgia. • Government provision of finance for machinery is seen as temporary and does not provide a good foundation for machinery dealers and service centres to develop their businesses in the long term. Existing dealers see potential opportunities in the market but will only develop their operations when there are long term arrangements in place, for provision of finance to its clients from the PFIs – they recognize that the government machinery program is not a permanent solution. • The government should stimulate PFI provision of finance for machinery, rather than providing finance to machinery buyers directly. Given the current lack of liquidity in the financial sector and the weakness in the agricultural sector, the PFIs will not take on this role quickly. The PFIs may need to be supported in providing finance for machinery. The steps for implementing this support should be as follows:  Cease government provision of machinery (as planned).  Transfer the budget from the government machinery program, to a government credit fund, to be lent through qualified PFIs. (A similar approach has been adopted in transferring the credit fund previously administered by the MED, to lending through PFIs) 75  Establish a credit line to qualified PFIs, under the following terms:  The interest rate to the borrower should be equal to the prevailing market rate charged by PFIs, which is derived from the central bank’s basic rediscounting rate. Such a market rate should cover the cost of funds, PFI’s operating costs, the cost of conventional risks and the PFI’s profit margin.  If the government wishes to subsidize provision of machinery, it could do this by providing a one-time matching grant towards the capital cost of the machinery, rather than through interest rate subsidy. The grant should be provided on the basis of clearly defined eligibility criteria, which will support small farmers/SMEs with low capitalization and low incomes borrowers with poor access to formal financial institutions. This will help small farmer/SME to bear the market-based interest rate without distorting financial markets and prevent crowding out of PFIs, by government programs offering cheap credits.  The interest rate from the credit line to the PFI should not be lower than the basic rediscounting rate of the central bank (the bank rate) or the average cost of savings deposits in the economy, so that the credit line does not discourage PFIs from mobilizing savings.  The government should aim for an arrangement whereby the PFI assumes 100% of the risk. However, if initially banks are unwilling to borrow from the credit line under these conditions, there are a range of options between the banks bearing zero risk and full risk. However, it is strongly recommend that in such cases, in the short term, the PFI, should assume not less than 50% of the lending risk. In the medium term (or whenever PFIs express interest), as PFIs develop more experience in machinery lending, the PFIs may assume the full risk of lending.  Gradually phase out the credit line as liquidity in the financial sector improves and when PFI are willing to lend their own funds for machinery. • A preferable alternative would be to have a non targeted credit line which farmers and agribusinesses can access for a variety or working capital and investments needs, rather than one specifically targeted at machinery. This would provide borrowers with greater flexibility, diversify the loan portfolio financed by the credit line and reduce lenders risks. • In reforming the machinery program, the government should consult with private sector machinery dealers as well as the PFIs, on a long term strategy for provision of machinery and servicing. 186. This program would continue to require substantial public funding in the medium term but the burden on the budget would decline in the long term, as when the PFIs lend more of their own funds. Irrigation and Drainage Off farm system: Delay privatization of the LTDs and prepare financial and regulatory aspects of a public private partnership with LTDs before privatisation, or, maintain the LTDs under public ownership. Invest in rehabilitation of the off-farm system. 187. Privatization of off-farm systems is uncommon: The government plans to privatize the four LTDs operating the off-farm irrigation and drainage system within the next 76 few years. Privatization of off-farm systems is uncommon, firstly because the operation of such systems is often not very profitable and so there are few interested investors, and secondly because government usually consider it important to maintain some control over the nation’s water resources, the management of which have great social and environmental implications for society. These systems are likely to be particularly unprofitable for water suppliers immediately after rehabilitation because farmers do not adjust quickly to the full cost of water, pursuing non- payment is difficult and investment costs are high. 188. Some form of public private partnership (PPP) may be more appropriate than outright privatization: If government does wish to proceed with privatization, it would be wise to consider alternatives to outright privatization. One option would be a public private partnership agreement whereby the state maintains ownership of the assets (the off-farm system) and grants a private operator the right to operate and profit from the system under certain conditions. These would include minimal investment in the system by the private operator, mutually agreed water charges and minimum standards of services, which would be monitored by a regulator. 189. A package of public finance and arrangements for regulation of the LTDs will need to be put in place before privatization: Regardless of the form of privatization or PPP, some package of publicly grant funded rehabilitation of the system and arrangements for regulation of LTDs, will need to be in place before privatization, for the following reasons: a. The LTDs will only be able to recover the full cost of services from AAs (particularly if they wish to be paid fully or partially in advance) and become financially viable, once they have established a record of reliable service with their clients. This will not be possible until further off-farm infrastructure rehabilitation is undertaken. The LTDs are not able to secure finance for rehabilitation because of their extremely weak balance sheets and cash flow. The government is currently providing soft loans to the LTD to undertaken rehabilitation but if the LTDs have to repay these loans, the resulting cost of water will almost certainly be more than farmers are willing to pay at the moment and the LTDs will accumulate an unsustainable level of debt. Further grant based public funding of infrastructure rehabilitation, will therefore be necessary, before and after privatization. b. Privatization will result in four natural monopolies because the physical nature of the system, meaning that AAs will not have a choice of supplier. Some form of regulation will therefore be required to ensure that the monopolies do not generate supernormal profits in the absence of competition and that they provide high quality services. On-farm system: Restart capacity building of AAs. Invest in rehabilitation of the on-farm system. 190. Development of the AAs is a pre-requisite to successful privatization or indeed continued public management of the system: Investment in a program to develop the capacity of the AAs will be a pre-requisite to successful privatization - it is unclear who the clients of the privatized LTDs would be if there were no viable AAs, since it would not be feasible for the LTDs to agree contracts with such as large number of individual farmers. 77 191. The law on amelioration also needs to be reviewed to clarify a number of unclear statements regarding the rights and responsibilities of AAs Seeds Align legislation with EU marketing regulations. Establish a national list of varieties. Invest in skills and facilities for VCU testing, DPU testing, seed certification, and seed inspection. Aim to acquire ISTA and OECD seeds scheme membership in the medium term. 192. Poor seed quality is a major cause of low productivity. A seeds testing and certification system should be established in order to ensure that farmers have the information they need to determine the quality of seed and to improve Georgian seeds breeders’ access to EU markets. This program requires legislative reform but only minimal public funding and does not imply an increase in staffing. Key reforms should include the following: i. Amend the seeds law to require national listing of varieties, testing and certification. Align supporting regulations with EC Seed and Planting Material Marketing Directives. ii. Establish capacity in the National Service for laboratory testing, field inspection and inspection at the borders. iii. Examine options for management and financing for a seed certification and testing system, which may include a voluntary or compulsory scheme and public and or private management and financing (although a compulsory scheme meeting ISTA standards would be required to access EU export markets). iv. Aim to acquire International Seed Trading Association (ISTA) certification in 3 years and OECD certification in 5 years. v. Remove the VAT on seeds to remove the incentive for traders to import seed as feed, to avoid VAT, which creates unfair competition for legal traders. Sanitary and Phytosanitary Align legislation with EU standards. Conduct reform of the national service in line with WB 2007 action plan. Establish laboratory testing and inspection capacity. 193. In order to gain greater access to EU and other markets and to protect public health, SPS standards should be aligned to EU standards and NS capacity developed in line with the recommendations of the Bank’s 2007 Action Plan for National Service. This program requires legislative reform and public funding. Key reform priorities include: i. Termination of the suspension of Article 14 of the Food Law, completion of registration of enterprises as planned and allowing inspection of enterprises handling food by inspectors. ii. Alignment of plant health and plant protection legislation with EU standards. iii. Establishment of capacity for laboratory testing of food products and agricultural chemicals . Examination of options for private sector involvement in the management and financing of these services. 78 Veterinary Services Reform the law covering veterinary service. Upgrade veterinary services in line with international OIE standards based on the OIE gap analysis. Establish disease control strategies. Invest in development of private vets and public service contracts with private vets. 194. The International Organization for Animal Health (OIE) is expected to undertake an evaluation of the animal health service in Georgia which is expected to provide a gap analysis. This would provide a strategic plan for investment to upgrade the service to a satisfactory level, in accordance with the WTO and international standards. 195. The strategic plan would provide plans for control of contagious diseases, including development of national animal disease information systems, disease surveillance systems, improvement of laboratory testing capacity, comprehensive vaccination programs. 196. As well as measures to control contagious diseases, the OIE recommendations are likely to include legislative and institutional reforms to promote the development of private veterinary services, including the licensing, supervision and training of private vets. Marketing and Advisory Services Establish performance based public service contracts with private service providers for advisory services. 197. There is a need to improve technology transfer to farmers and agribusinesses. While this will require long term investment in research and development, the immediate priority is to extend information about existing technologies to farmers and agribusinesses. Given the weak public institutions in the agricultural sector and government’s vision of a small efficient public sector, it would not be appropriate to establish a public extension (agricultural advisory) service at this stage. However, there are a number of agricultural service centres and NGOs which have experience in providing advisory services for donor projects, which could be contracted by government to deliver advisory services. This would require a small unit in the MOA to prepare terms of reference for service providers and to monitor their performance as a basis for payment. 198. An alternative model would be to provide funding directly to community based organizations which would be established to procure services on behalf of its members, who would be farmers and other rural citizens interested in receiving advice. Individually, small farmers would have difficulty procuring advisory services but a membership organization can do this on behalf of all farmers in a community. A similar model is currently being developed in Kyrgyzstan under which farmers will make increasing contributions to the costs of services. The Municipal Development Fund (MDF) may have the relevant experience to support implementation of such a program. 79 Support replication of donor project examples of supply chain development. Examine possible public investment to support the establishment of wine sector marketing organizations, as outlined in the draft wine sector study, 2009. 199. Investment in private marketing services, including storage, cooling, grading and transport facilities, particularly for citrus, fruit, vegetables and livestock products, can best be undertaken by the private sector. However, there is considerable experience amongst donor projects in supporting supply chain development, which could usefully be demonstrated to private investors considering investing in this field and replicated by future donor projects. Implementation of such schemes requires technical and marketing advice and finance. Technical and marketing advice could be provided through the advisory service arrangements described above. This would complement the provision of finance which could come through the government’s credit program through PFIs. 4. Land Market: Further development of the land market to provide the foundations for a stronger land market in the long term. 200. Although the land market is currently somewhat inactive, the government should resolve the remaining constraints in the land market in preparation for a more buoyant market for land, once the competitiveness of the agricultural sector improves. There are a number of measures which could be undertaken to help develop the land market, as follows: a. Identify those areas where there may be inaccuracies in mapping and where there may be substantial land market activity in future. Systematically verify the legality of land rights documents and accuracy of cadastral maps and reissue these where necessary. Blanket remapping throughout the country is not required. b. Develop skills and institutional arrangements for land valuation. No institutions for land valuation currently exist. c. Produce comprehensive 1:10,000 maps as a basis for land use and rural development planning. In 2006, Georgia produced a very limited number of new digital topographic maps on a scale of 1:10,000 in Georgian and English language, along the 5 km border strip in the South of the country. Comprehensive map coverage of all economically active areas in Georgia with this digital topographic map is an important prerequisite for successful rural and regional development planning. Maps inherited from the soviet period in paper format are not suitable for planning purposes and some of the maps produced after independence with the support of donors, after independence, are becoming out of date. d. Pilot and develop skills in voluntary land consolidation. The consolidation of smaller land plots into larger plots, will mainly take place through individual market transactions over a long period, if the competitiveness of the agricultural sector increases and if non-farm job opportunities emerge. However, there may be cases where facilitation of land consolidation by government would allow certain rural developments to take place. These may include infrastructure projects and expansion of settlements, protection and restoration of water resources and conversion of agriculturally inferior land into forest lands. In other cases, there may be interest from the majority of small farmers in a community to merge their 80 fragmented land parcels and to create larger individual farm holdings or to form associations. Pilot land consolidation efforts supported by KfW, indicated that more than 60 percent of the small owners in some areas would participate in efforts to increase their farm sizes and merge their land parcels. In such cases, there may be a role for government to facilitate the process but there is a need to examine methodologies for facilitating land consolidation and to develop skills in this area. In all cases, such facilitation should only take place where there is a genuine demand from the majority of the community and through voluntary participation. 5. Conclusion 201. The recommended reforms will help to promote equitable growth in the rural economy. Further design of each of the proposed reforms should include intensive consultation with the private sector and examination of opportunities to involve the private sector in financing and managing services. Reforms should also be designed to ensure that any regulation does not create barriers to entry of new businesses or create opportunities for corruption, a challenge which Georgia has successfully dealt with in many other areas of the economy. ______________________________ 81 Annex 1 Map of Georgia 82